Trader’s Narrative

With the market pushing ahead into new highs for the year, here is this week’s sentiment overview:

Sentiment Surveys:
The average retail investor in the US, as measured by the weekly AAII sentiment survey was less bullish this week: 35.4% down 9.9% points from last week. Those that abandoned the bullish camp were evenly split between undecided and bearish: neutral at 34.8% up 5.3% points and bearish at 29.9% up 4.6% points. Since the long term average for bullish sentiment is 39% we aren’t seeing a very lopsided position here.

Investors Intelligence
ChartCraft’s measure of newsletter editor sentiment showed slightly more bulls: 46.1% and slightly less bears, 21.3%. The rest, 32.6% are looking for a market correction. Putting those numbers into historical context, once again, we find that this measure is stuck in “no-man’s land”.

Daily Sentiment Index
The DSI for the S&P 500 index hit a high of 84% twice this week on March 17th and 18th. The 5 day moving average closed at 81%. While we’ve seen this metric hit higher extremes, this is clearly a sentiment level that has previously corresponded to market tops.

NAAIM Survey of Manager Sentiment
This up and coming sentiment survey is flashing a bright red light for the market. As of this week, active money managers are as bullish as they were in October 2009:

But the chart above is showing the mean (or average) market exposure. If we instead look at the median, which some would say is a superior statistic, then it is even more extreme at 95% net long. This is the highest level of bullishness going back to… you guessed it… October 17th, 2007 - when the last cyclical bull market topped out. But keep in mind that we saw this level of bullishness several times before the market peaked: in early 2007 and late 2006.
Continue reading ‘Sentiment Overview: Week Of March 19th, 2010′

One of the reasons why market technicians believe that we are still in a primary uptrend is the incredibly strong advance decline lines for major indexes. The NYSE advance decline is the most common but I refuse to consider it an accurate measure of the stock market. Unfortunately, it has become too warped by the inclusion of non-operating company securities. Most of these are interest rate sensitive issues so they move in tandem with the bond market, not the stock market. This is why the NYSE breadth can mislead you and why I refuse to use it.

There are several ways around this. One is to look at the NYSE operating company only advance decline line. This is a bit hard to find because of the work involved but usually top notch firms like Lowry Research and Ned Davis Research have it. The other, more simpler way is to sidestep the whole issue by looking at the advance decline line of an index which is composed of operating companies. For example, the cumulative advance decline line for the S&P 500 index.

Click to see a larger version in a new tab:

This breadth measure is critical because it is telling us that as the S&P 500 index rises, it does so powered by a majority of its constituents. This is not a case where a few stocks are receiving the bulk of buy orders and dragging the index up grudgingly (like we saw in the later stages of the tech bubble in 2000). As well, if you caught the recent interview with Richard Dickson of Lowry Research, he mentioned that we are seeing the advance decline lines for major indexes lead the market higher.

You can clearly see that this is the case with the S&P 500 index advance decline line. It took the S&P 500 index itself until March 16th 2010 to decisively break above its January 2010 highs. But the cumulative advance decline line for the index surpassed its January high much earlier, on February 19th, 2010. But it has yet to surpass its previous high set on October 12th 2007.

Also, note that it set an earlier peak at 13592 on July 12th, 2007. And that if we step back, from early 2007 until early 2008, the cumulative advance decline for the S&P 500 index basically meandered sideways, unable to make headway in a concomitant uptrend with the index that it is suppose to track. Here’s a longer term chart for the S&P 500 index advance decline line going back to 2003:

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Usually advance decline lines will top out and start to decline ahead of major market indexes. Clearly we are seeing the exact opposite of that right now. The other market internal metric which is critical is the number of new highs. As long as we have the market showing a significant number of new highs, the bull market is intact. Historically, the number of new highs peaks ahead of the market by a year or so. Right now, we are seeing the number of new highs (or their relative number) hit new highs itself. So again, we are seeing the opposite of we would see at a major top.

Having said that, I am very cautious in the short term. While I do believe that we are still in a primary uptrend, based on these breadth metrics (as well as Wayne’s excellent recent post on tape reading) it is important to be cognizant of the short term clouds forming over the horizon.

Last week QuantDNA sent out a cryptic message that we had reached an important exhaustion pattern according to their black box.

It seems that they are very serious about this and have reiterated the signal this morning with some more information:

As we approach the end of the week, the end of the quarter, Triple Witching Day and a full year of unabated bullishness of historical proportions, we can’t help but take pause as our full symphony of exhaustion patterns tip their hat. Specifically, 4 patterns that we refer to as the “Fab Four” have fired in the last 2 days, rounding out what we believe is a very telling market condition when viewed in context with last weeks “Dynamic Duo”.

We are fully cognizant of the cynical conclusions that some might draw when looking at colored circles on top of a chart without the specific drivers and therefore caution readers to make their own independent decisions and conclusions and refrain from making investment decisions based on black-boxed algorithms. We are nonetheless bringing them to your attention and offering no guarantees, only probabilities. History will be the ultimate judge.

The charts below feature prior instances where the Fab Four appeared in such tight proximity to each other…

The decision is up to you whether you want to pay attention to this modern soothsayer’s warnings about the Ides of March. QuantDNA clearly has enough confidence to put their burgeoning reputation on the line. We’ll see how things shake out soon enough.

Lowry Research, while bullish in the longer term, is also calling for a short term correction. Personally, I’m seeing a lot of other things which point to the same conclusion. For the details, watch for the sentiment overview coming up later today.

This market has shrugged off basically everything thrown at it: unemployment, consumer sentiment, sovereign debt crises in Portugal, Spain, Italy, Ireland and Greece, the list goes on and on. The latest is the concern that the US and other large Western countries like Germany, France, and the UK would lose their gold plated AAA debt rating.

In the most recent Moody’s quarterly “Aaa Sovereign Monitor” report, they cite concerns about “debt affordability” and hint that it is possible for the unthinkable to happen. This of course was picked up by all major media outlets and the echo chamber went into full effect.

Source: Moody’s Says U.S. Debt Could Test Triple-A Rating

I’m sure that a lot of people who want to believe in the bear case will jump on this because it makes a lot of sense. But let me explain why I think this is nonsense and just another brick in the wall of worry.

First of all, why in the world would anyone listen to Moody’s? or any other rating agency? If anyone had a doubt before the credit crisis, their behavior as the courtesans of the sub-prime fiasco cemented the fact that their opinion has absolutely zero relevance to actual market reality.

Second, if you actually read what Moody’s wrote in their report you realize that the media has exaggerated to a large extent their message. First of all, the title of the report is, “AAA Governments Have the Capacity to Rise to the Challenges They Face”. Beyond that, here are some excerpts:

The ratings of all Aaa governments are currently well positioned despite their stretched finances…

The recovery that has taken hold across the global economy remains fragile in several of the large advanced economies, most of which have also implemented the most aggressively expansionary fiscal and monetary policies.

…debt affordability — i.e. the ratio of interest payments to government revenues — indicates that the ratings of all Aaa governments remain well positioned, despite the reduction in their ‘distance-to-downgrade’ and the widening of tail risk…

…the Aaa ratings of the UK and the US, whose debt affordability is currently the most stretched, continue to be supported by substantial ‘debt reversibility’…

Debt reversibility is where a government is able to heal itself, fiscally, after an economic shock. So basically there is nothing new here. Moody’s is saying that things got really bad, now they are a little better but we have to be careful going forward because things are really uncertain at this point. But let’s say that the exaggeration of this message is true and the US will lose its vaunted AAA rating. What will that mean exactly?

The assumption obviously is that international lenders would require a higher interest rate to lend to the US because of this alleged downgrade. But is that true?

To find out, listen to David Rosenberg. He continues to be a growling bear, and once again finds himself mostly alone, just like back in 2007. But he does not succumb to this alluring argument and instead marshals facts instead of opinion and emotion:

Canada was pushed out of AAA on October 14, 1992 and did not regain that status until July 29, 2002 — and over that time frame, the yield on the benchmark 10-year Government of Canada bond tumbled from 7.84% to 5.29% (that 255bps decline compared with a 189bps decline in comparable U.S. yields over that time frame).

Japan lost its AAA rating in February 2001 and over the next three years, the 10-year JGB yield still ended up declining almost 100bps to the lows two years later and the yield is still lower today than it was at the time of the downgrade.

Screaming headlines that warn of the US losing its status symbol of the highest debt rating may grab attention but just like the interest rate myth, I think we can safely consider this a non-issue. But as long as people view it as a concern, it will just be yet another brick in the wall of worry that the bull will climb - to the astonishment of almost everyone watching.

This is a guest post by Wayne Whaley, CTA:

Over the last 12 months, I have posted several articles concerning the bullish nature of tape action during 2009, specifically the repeated thrust signals that have occurred over the last 12 months coming after the selling capitulation in October 2008.

Recently, I received an inquiry from a reader about what it would take for the tape to give me a bearish signal. Here is the start of a response: In January of 2010, I wrote a 17 page paper on reading the tape. The following is a summary of a tidbit of that paper related to negative tape action. My analysis is of an intermediate nature.

There are a couple of different tape observations that would cause me concern. The first is a long period of time with no signs of either a selling capitulation or a thrust signal. The second would be signs that the market is confused with unusually large numbers of issues going in different directions. Today, I will address the first of those two concerns.

For a little background, my paper identified conditions related to thrust or reverse thrust (selling capitulations) that were extremely bullish. We have touched on many of those recently. I outlined in my paper, 51 of these signals from 1970 through 2009. Assuming that each signal is good for 12 months and eliminating repeats, the 51 signals condense to 12 time periods. Below are the results for the S&P 500 during the signals, assuming that you exit long positions 252 days after the last observed signal.

Any time within the 252 day thrust signal period that a new signal was observed, the long exposure was extended an additional 252 days (approximately 12 months). For example, in the third period listed, an initial “price” thrust was observed on October 10th, 1974 and then a “breadth” thrust was observed on October 11th, 1974, January 6th, 1975 and January 6th, 1976 extending the exit date to January 7th, 1977 (252 days after the last signal on January 6th, 1976).

We reviewed the bullishness of the breadth and volume signals recently. Today, I want to address the question of how long the market needs to go without a signal before we should grow concerned.
Continue reading ‘Searching For Bear Tracks In The Tape’