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.
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.