It seems that the noise all last week was about what to short as the S&P 500 started breaking below its support line in the sand. However, on Tuesday this week, just as the market broke 1100 support from August 09th, it trapped a lot of bears by doing a quick reversal.
Why didn't we go lower? Well, we still might to be honest with you. However, one can argue so many different reasons why the market staged a rally both fundamentally and technically, neither of which really move it like emotion can. So my answer today focuses on contrarian analysis and looks at extreme bearish sentiment, which is now squeezing the shorts that joined the game late.
So after a three day power rally, many are calling this just a plain vanilla short squeeze, but does the market have juice for further gains? According to contrarian sentiment survey's it just might.
Investor Intelligence Survey
On Wednesday, Investor Intelligence survey reported that newsletter advisors who were bullish stood at 34.4% and while the bearish advisors stood at 45.2%. This is now the highest reading since March 2009 and the readings are 1 standard deviation above mean. Historically, this type of a reading has always signalled very strong positive returns going forward, but sometimes drawdowns can be quite excessive. For example, in late 2008 pessimism remained high for awhile.
American Association of Individual Investors
On Thursday, AAII survey reported that individuals who were bullish stood at 35.2% and while the bearish ones stood at 45.7%. We aren't as extreme in readings when it comes to this survey, however pessimism is on the rise here too. The best way to follow this indicator is to apply a 4 week moving average, as weekly readings tend to be quite volatile at times. Further selling could have pushed us to that extreme 2 standard deviation territory last seen in March 2009, but we never really got there.
National Association of Active Investment Managers
NAAIM survey reported on Thursday that fund managers recorded the first net short exposure towards US equities in a very long time. In other words, fund managers believe now is the right time to short equities, with average exposure sitting at -3.6%. This is now the lowest exposure to stocks since the first week of October 2008. Historically, last six times managers had exposure to equities lower than +5%, S&P 500 returns were positive 100% of the time on average gaining 4%.
Hulbert Newsletter Stock Sentiment
Newsletter advisors tracked by Mark Hulbert showed average equity exposure recommendation of -16.8% net short. That is the lowest reading since the first week in March 2009, just as the stock market bottomed. The chart I have is not my own, so I will not update it, but historically the returns were quite good when this much pessimism was present.
Since the start of the secular bear market in March 2000, anytime the sentiment survey dropped this low, the S&P 500 was positive a month later 13 out of 13 times or in other words 100% of the time. However, the data does not include late 2008, when negative readings weren't enough to stop an almighty post-Lehman crash. It should remind all that contrarian analysis is very good tool, but not a holy grail. So it works almost always, until it doesn't and that it wipes you out hehe!
Market Vane Bullish Consensus
Market Vane bull readings are compiled by tracking the recommendations of leading market Commodity Trading Advisers also known as CTAs. This sentiment survey does not work on a range level similar to II, NAAIM or AAII, but more so on a relative level with regards to the price and standard deviations.
Keeping in that in mind, the current reading stands at 44% bulls. Relative to that, other major bottoms like March 2009 had readings of 33% bulls and July 2010 had readings of 39% bulls. Recent readings of major tops stand at 60% bulls for April 2010 just before the flash crash and 66% bulls during February 2011, just as the Financial Sector topped out. Therefore, currently the readings are very bearish indeed, but maybe not as extreme just yet.
Summary
Contrarians who feel like dare devils, stand a good chance of catching a multi-week rally from these levels due to extremely negative sentiment towards stocks. Having said that, the market could keep squeezing shorts for much longer as majority feel very negative towards equities and expect a recession with a big bear market like a repeat of 2008, that is still stuck in the minds of investors. I believe we won't get either!
Note: Say that you are willing to play the long side here. A word of caution. We just had 3 days where the S&P 500 posted gains of more than 1%. The wise thing to do is not to jump in right here right now, but maybe wait a day or two or even a week, where a potential pullback occurs.
it looks like you have been very eager to post about stock sentiment, breadth and technicals as of late. your posts were mainly focused on the dollar, but now refocused towards stocks.
ReplyDeletewhy is this so?
Anonymous - very interesting question. Ok so as extreme bullish sentiment on the US Dollar and Treasury Bonds hits an inflection point, money flowing out of these asset classes is running straight into so called risky asset. These include commodity currencies, asian export currencies, global equities, crude oil, copper, high yield corporate bonds and others.
ReplyDeleteMajority of the time investors feel the most comfortable by investing into stocks. I don't know why that is, but it seems to be so majority of the time. So therefore I have placed a decent amount of effort in the last two weeks portraying to various readers of my blog why they could be contrarians within the current selling environment if they chose to trade an opportunity.
I guess it all depends on ones time frame, because for me, on any serious pullback I still want to be a buyer of US Dollars and see the current risk rally as more of a short squeeze than anything else. Having said that, this rally could go for awhile - there are many short sellers to be squeezed!
Tiho:
ReplyDeleteFine update.
I understand that there is a lot of money on the sidelines in US and unlike your country where one makes 6% in the US you need a microscope to see the interest rates being paid.
What needs to happen to shift your thinking that the US stock market could have a bigger run into next year beyond a short squeeze for the next month or two?
Thank you
That is actually a great question - even better than the one above, no offence. I can actually number a lot of things either economic, market or credit market wise. I can talk for hours and hours about nonsense, but I will not bother. Those are not necessary right now and there is a short cut to it all. You know what that is? The Market.
ReplyDeleteThe market will tell you. Just follow the market, follow the tape, follow the money. The market will tell you if you can see it...
1.) A condition where super bullish stocks like Apple correct meaningfully. Others include Amazon, Wynn Resorts, Hermes, Mulberry etc etc. During macro sells offs, the whole market goes down, there should be no exemptions. I would like to see Apple at least around $250 before the bear market is over. I cannot understand the super bulls, as they keep claiming Apple is always going to go up. It seem that its a better safe haven than Treasury Bonds, US Dollar, Swiss Franc, Japanese Yen or Gold. Give me a break...
2.) We can talk about Greece, Italy, China, Credit Freeze, and god know what else. it is all impacting financial sector. But do you know what will tell you the market is bottomed? Financial sector. Financial are the main column of weakness and current problems. If Financial stocks start outperforming the overall S&P 500, that means we have discounted "everything". Last time that happened was in March 2009. Currently we are not close to that yet...
3.) Extreme optimism towards the US Dollar. Yes we have some bullishness as I have stated before so a pullback is overdue. But US Dollar negativity has been so strong and so intense for the last couple of years. So much of this hate needs to be "shaken off" and investors need to fall in love with this currency again. We need deflationists to come here on my blog and flame me and tell me that I was wrong with the US Dollar. Than we can short it and than everything else will go up and the Dollar will make new lows below 2008. Obviously, the catalyst will be that Bernanke printed much much more money.
So first, the strength internals of the market like Apple need to correct. Second, financials need to bottom out and start outperforming, which means credit risk is calming down. Third, investors love for US Dollar needs to comeback, but not just for a week or two or three!
It is so easy when you just put it all out like that. Very creative at thinking!
ReplyDeleteMark
Thank for your useful update.
ReplyDeleteI doubt on second point. Maybe financial sector rebounds the most only because they fall the most rather than discounting all of uncertainty.
Hey Bo, I'm not saying that it is going to happen now. I'm not say Financilas are going to outperform meaningfully and on consistent basis for months.
ReplyDeleteI'm just saying that from March 2009, Financials outperformed the overall market for months and months very powerfully. That is a sign of a real bottom. So all I am saying is that today we don't have that and that type of price action is necessary to confirm a proper more meaningful bottom.
Also to note: Barton Biggs, the perma bull, has capitulated. Bloomberg wrote:
ReplyDeleteThe threat of a recession spurred Barton Biggs to cut bets that stocks will gain to 20 percent in his hedge fund, down from as much as 85 percent six months ago, the founder of Traxis Partners LP said on Sept. 22.
“I wish I was zero,” Biggs said on Bloomberg Television’s “Street Smart” with Matt Miller and Carol Massar. Markets are telling policy makers that “they’ve got to change and act or we’re going to go into a double-dip recession, and we’re going to go down another 20 percent,” he said.
Thanks for the update.
ReplyDeleteMy greatest fear when using sentiment info as investment/trading tool in bear market enviroment is the possibility of huge drawdown.
It is illustrated in the following blog post :
http://blogs.decisionpoint.com/chart_spotlight/2011/10/bearish-sentiment-not-always-a-bottom-picker.html
I agree with you Andreas. Nothing works perfectly. However, you cannot just use one set of tools like sentiment. It always good to get confirmations.
ReplyDeleteThere are many differences between October 2008 and today.
I can tell you one basic one. In October 2008, Treasury Bonds did not spike to extremes until later in November and December. Today, they have already spiked and sort of discounted some bad news to say the least. Therefore,, unlike October 2008, I think Treasuries are now going to have a meaningful corrections and the money will flow out of bonds back into equities.
Another one? During October 2008 there was no divergence between 52 Week New Lows indicating selling exhaustion. There was also no divergence in 10 or 21 Day Advance Decline Line. Today? yes for both are diverging. Just visit my previous post on Breadth.
During October 2008 we didn't have extremely negative sentiment on other risk assets apart from stocks - today we do. You see back in September and October 2008, currencies like Aussie Dollar (barometer of risk) just started falling and speculators were slowly cutting their positions. Today, we have a sell off and traders are already bearish on the Aussie.
Finally, in October 2008 VIX reading was at a two decade average - around 20. Earlier this week, VIX was at 46. Historically you do not get such huge moves, like October 2008, from such high levels of VIX.
One cannot just use sentiment, like that gentlemen did in the article. You should use variety of tools including sentiment, breadth, technicals, cross asset correlations for confirmation etc etc etc. And some many are just looking at 2008 as a blueprint. It's not going to be 2008!
But I agree with the original article you posted, which outlines that in a bear market the smartest thing to do is wait for the end of it.
I'd like to add an another smart idea : long europe, short us.
ReplyDeletehttp://pragcap.com/point-of-maximum-pessimism
Andras, I agree with you.
ReplyDeleteMarket sentiment is extremely bearish, but market still no longer rebounds.It is a bad sign,so I wait for some technical indicators of trend following to give me signals to entre the market with bearish sentiment.
Back to market sentiment, more investment managers has capitulated but some of economist still are quite optimistic towards economy.
If the Fed Anxious index reflecting economist's opinion reach a higher level, the market is close to trough with high possibility.
The web site and the chart is as follows.
http://www.philadelphiafed.org/research-and-data/real-time-center/survey-of-professional-forecasters/anxious-index/
http://www.philadelphiafed.org/research-and-data/real-time-center/survey-of-professional-forecasters
Nice call on the market over the last couple of weeks. Your posts really set the stage for this rally. Nice blog!
ReplyDeleteYes, thank you. Here we are now 11% higher as of last nights close and it has only been a week or two since I wrote my sentiment articles on the blog. I think too many investors got too bearish, too soon and yet we didn't even go lower than August 09th futures bottom of 1075.
ReplyDeleteI read a few blogs which are "popular" and the stuff these guys were spinning was unbelievable. If you were to read these articles, for a second there you would have thought the whole world is on a brick of total collapse.
I mean its quite funny how common sense was not present for majority... again. You see, the price stayed the same over the last couple of months, and yet sentiment got so negative and so bearish as of late September and early October.
Besides, there is still no recession with the current data. The bears insisted that a recession was a 100% done deal in August and yet it doesn't look so as of today. While I've maintained my outlook for no recession this year, I think next year will be different. More weakness is coming after this relief rally.