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Sunday, February 3, 2002

After a good week-and-a-half of sentiment extremes, we’re now back in no-man’s land.  STEM.MR did a great job this past week of tipping us of to selling short at 1135 on 1/28, then cover and go long at the 1090-1094 area on 1/30, then cover our longs (or at least move up stops) on Thursday.  That’s 80 S&P points captured in the matter of a week. Using just 1 S&P futures contract, that would have paid for 33 years’ worth of subscriptions to sentimenTrader.com.  Now that’s value!  In all seriousness though, this model will capture most of those types of moves, but you need to be careful to always use stops in case sentiment extremes get even more extreme.  No model that I know of is perfect.

We haven’t seen a week like that in a long time.  We saw the VIX go from 21 to 30, then go right back to 23;  the TRIN go from over 3.00 to under .55;  and TICK readings go from -900 to +1000.  We even saw a Put/Call reading of over 1.00 (bullish) in the same week we saw an Open Interest Put/Call reading over 1.40 (very bearish).  It’s crazy stuff, but that’s what makes us money.  I suspect that we will not see that type of activity again for quite some time, unfortunately, as periods of hyper-activity lend themselves to periods of quiet.  It’s very analogous to the St. Croix River in upper Wisconsin (my old and current stomping grounds) – a lazy, meandering river punctuated by stretches of boiling rapids.

Enough about last week – where do we stand today?  Well, let’s take our models one at a time…

STEM.MR – Officially, our last signal was a BUY on 1/30, but like I’ve said, we pretty much covered everything on Thursday.  So, we’re essentially sidelined in this model for the time being.   The current reading of just under 60 is neutral and doesn’t show any signs of budging, as all components are firmly in neutral territory.  Remember that this model compares its components to historical movements from its mean, so we’re not concerned about absolute levels.

STEM – Once again, we’re neutral in this model, though it’s reaching a fairly bullish reading at 64.  However, the readings of the past couple of days will drag the index down before giving us an actionable signal.  I really don’t see any signals coming from this model for at least a few days at best.  We ARE concerned about absolute levels in this model, and we have a two in particular – the TRIN and VIX – which are at opposite extremes.  They cancel each other out in the model, however, so the net effect is negligible.

AIM – The week of 1/22 – 1/25 was range-bound for the market, so our numbers here didn’t move a whole lot, though we actually became more bearish in this model as we moved down 8 points from 29 to 21.1.  That fits nicely with last week’s sell-off.  It will be quite interesting to see if last week’s action had much of an impact on investor’s moods.  Typically extreme volatility will make them more cautious, so we’ll see if that plays out this week.

I trust you can see the potential of a move when all three models are in alignment.  We entered last week with all three of our models giving firm sell signals, and the move was impressive.  In last week’s commentary, I stated that if we saw fireworks, it would likely be on the downside.  But like we say on our main site, you don’t necessarily want to ignore shorter-term signals when they conflict with longer-term signals.  If you do that, you would have missed a 40-point move in the S&Ps from the long side on 1/30.

Currently, our outlook is mixed.  We are not at extremes in any model, and don’t really anticipate being so for awhile.  If pressed, I would say we have further to go on the downside before a firm rally can take place.  Ideally, we will see a move back down to retest last week’s lows and then rally from there.  But let’s take one day at a time and let the market tell us what to do instead of the other way around.