Mar 03, 2002

sentimenTrader.com

Sunday, March 3, 2002

Last week was a rough week for us. We suffered our first loss of the year (actually our first loss in any model in a long time), and we weren't able to capitalize on some movement that we normally would have been able to. To be perfectly frank, I'm not quite sure why that was. Sentiment just did not have much of an impact on trading last week, and it threw our models for a loop. That's one of the reasons I stress constantly that this is not a trading service - you probably will not do very well just following our signals blindly. You must have a disciplined methodology to enter and exit the markets. Anyway, the one call we did nail was on Thursday, I mentioned in the daily commentary that the STEM.MR model was coiling up into a triangle. That's a very rare occurrence for this model, and I said that it portended a big move one way or the other. I thought the move would be down, but so far I'm wrong as we had a pretty impressive rally on Friday. We issued another SELL signal in the STEM.MR model on Friday afternoon at 1124 and we're already down a quick 7 points on that signal. I hope you had the discipline to not short a rising market - price action always comes first and ANY indicator should always play second fiddle.

Let's look at what we see this weekend for sentiment:

BULLISH

* The CBOE put/call ratio has been persistently high for several days (weeks, actually) on end. If you look at some of the moving averages, you can see that a large number of puts have been trading over the past two weeks. That's a sign we don't see very much, as many options traders will only buy calls. As hard as that is to believe, it's very true that most investors and even traders have a bullish bias and will not, for whatever reason, buy put options. Only on Friday did we finally see call buying become "hot" again.

* Many of the sentiment surveys became quite bearish, with the notable exception of Investor's Intelligence. Those numbers are finally becoming more constructive after staying rather steady for a long time.

* Bond yields reversed their recent slide and have begun moving back up. This suggests asset allocators are moving money out of bonds (simply, if insitutions pull money out of bonds their price will fall and since bond price and yield move in opposite directions, the yield will rise) and into stocks. NOTE: This relationship does not always hold true. In fact, in the long-term, bond yields move inversely to stock prices. However, we have seen over the past two years that bond yields and stocks are moving in tandem. This sometimes happens in a deflationary environment. In any event, this shows that the big money may be becoming more confident in the ability for stocks to give them a higher return than bonds at the moment.

* The DOW posted new recovery (post-September 11th) highs on Friday. This could/should engender a whole wave of optimism. Of course, we will look to go short when it gets out of hand, but on a sentiment basis, it should give confidence to a lot of investors who were on the sidelines, wanting to know if we are in a new bull market. There is a lot of cash out there waiting to be put to work, and it could take us much higher.

BEARISH

* Once again, Commercial traders (mutual funds, pension funds, etc.) increased their net short position in the latest week, while small speculators increased their net long positions. This is the third week in a row this has happened. Institutions increased their net short position from 60,000 to 66,000 contracts while small specs increased their net longs from 67,500 to 77,000 contracts. For the commercials, this net short position is in the bottom 8% of all readings for the past 9 years (meaning only 8% of the time have they been more short than they are now). For the small specs, this net long position is in the top 2.5% of all readings in the past 9 years (meaning only 2.5% of the time have they been longer than they are now). You can now draw a clear trendline from their September positions showing that the trend is decidedly not a positive one for the market.

* We've had no type of quick selling panic. We tested the monthly lows a couple of times, but there was no rush to sell. Typically good bottoms have at least one session like that. Also, the volume and breadth figures were not especially outstanding on Friday's rally. Good, but not great (I admit that's a bit nitpicky).

* The VIX. Ahh, yes, the VIX. Where to start? First of all, let me present you with a little historical context. Over the past few years, the VIX has dropped to the 18 area going into the summer months. For whatever reason, there is a contraction in volatility in that time period. It is possible that seasonal trend is beginning early. Also, it pays to keep this in mind...for the mid 90's, the VIX had a range of 10 on the lower end to around 18 on the upper end, so 20 or 21 or 22 is no magical number. There have been some interesting studies done correlating volatility to real growth in the economy. As growth increases, so does vol. If we are indeed entering a lower-growth period, volatility may return to more historical lower norms. But what about next week? Well, you can see on the chart that the VIX has now closed below 10% of its 10-day moving average, and the RSI has dropped below 30. Look at the last few times on the chart this has happened, then look at what the market did. The best way to predict future price action is by examining patterns of past price action. If the VIX goes any lower and reverses, that is one of the best individual indicators I know of to go short. Please note that I said REVERSES - you have to wait for it to begin going back up - don't anticipate or you could be torn to shreds.

* All of our .MR indicators are in the lower end of their trading bands, which is why we got such a low STEM.MR reading on Friday. We have seen some very decent down moves in the market after getting these signals in the past.

* STILL have the accounting issues. There was a very interesting article in Friday's Wall Street Journal about a small businessman who defrauded a major bank for several million dollars, because they relied on a top five accounting firm's blessing of this businessman's books (which were mostly bogus). The crook said he was so willing to cooperate because he wanted the world to know how easy it is to fool these auditors. One of the reasons we have such liquid capital markets is our transparency. If our transparency comes into question, so does foreign investment. In the short run, none of the implications from this mess are positive.

* The breadth oscillators are becoming overbought. They have not begun to reverse, so look closely at the A/D Breadth and NH/NL Breadth over the coming week to see how they are faring.

For the coming week, my instinct says we will challenge the 1140 level on the S&P, but probably will be turned back around that area and head lower. I still don't have great faith in this rally, and some of the bearish arguments above are extremely compelling to me. I am not a perma-bull by any means. In fact, some of our best signals have come on the long side. But over the past two months, I think we have just gotten too far ahead of ourselves and need some time - and better prices and sentiment - before we can move appreciably higher. I have to say, though, that technically the market had a very good day on Friday when it could have been very bad according to some of the technical indicators and patterns that were being reflected by Thursday's close. This leads me to believe that this rally could have much more steam than I originally thought. We will have to wait and react to what we see.