Monday, November 09, 2009

Sentiment Indicators Point To Another Market Bottom

(Note: this post originally appeared on Sunday, 11/8)

The S&P 500 closed above its 50-day average for the 2nd day in a row on Friday, a good sign that the market is continuing to bounce from its recent oversold condition, and quite possibly has seen its lows for the near-term.

A lot of technicians have been up in arms lately, saying that the market is poised to put in a "head & shoulders" top, and that the highs for the year are likely behind us. My response the whole time has been that we can't just look at the technicals in isolation, but rather the key to timing the duration of this correction would be how investor sentiment reacted to any market decline.

The technicians said the exact same thing back in July, when it really did look like a head and shoulders top was in, but a strange thing happened on the way to Armageddon. Investor sentiment quickly grew so bearish, that the market bottomed and began to move higher. As those bearish bets became losing ones, the bears slowly began to unwind them, and that added fuel to the fire and sparked a very solid summer rally.

With year-end not far off in the distant future, I would not be surprised to see a similar scenario play out in the markets now. While not every sentiment indicator that I follow is showing high levels of bearishness, enough of them are to suggest we have seen the lows in this most recent correction. To wit,
  • The AAII investor survey showed its most bearish spread between bulls and bears (22% bulls, 56% bears) since the week prior to the March lows. That's pretty surprising, and indicates just how skittish investors remain, as they jump to the bearish camp on any slight decline in the market.
  • The Rydex Nova/Ursa ratio, which measure market timers in the Rydex funds switching from bullish to bearish leaning mutual funds, has quickly moved to its lowest level in 2 years. That means there are more market timers leaning bearish than there was in October 2008 and March of this year. You can see in the chart below that when we reached these levels in July, the market had also bottomed and rallied from there.

  • In the options market, the 10-day CBOE put/call ratio has reached its highest level (0.97) since the July lows. Again, this indicates that over a multi-week period, investors have been loading up on put options either to hedge their portfolios or to speculate on further downside in the market. Either way, as these bets get unwound, it often adds upside pressure in the market.
  • Last, the chart below shows Citigroup's Panic/Euphoria Model. This is a proprietary index that measures many different things in the market to get a sense of investor sentiment. While it is not at incredibly bearish levels, I did find it interesting that despite the record rally from the March lows, that not once has this indicator moved closed to the "euphoria" levels indicated by the upper horizontal line in the graph. If and when we eventually reach those levels, I will agree that it is time to pull in my bullish horns.
From my perch, this has been a textbook correction within a bull market. The S&P 500 looks to have left another higher low in the charts, so I wonder if that will get the technicians to change their outlooks going forward. As a portfolio manager, I know too well the feelings of performance anxiety that come when the market is rallying and you don't feel like you are fully participating. I suspect more and more managers will experience this phenomenon as year-end draws closer, and the chase for performance will drive the market to new highs for the year.

long SSO


At 4:45 AM, Blogger michaeld said...

Yes, it looks like w had another bottom 10 days ago similar to the one in July.

I know, stocks have become much more expensive,and may consolidate a bit from where they are now.

However, using a good market timing system can help an investor profit both from the upside and downside of this market.


Its daily DJIA index trading signal is up a respectable 68% for the year (as of November 1, 2009) and it is free of charge for individual investors.


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