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Sunday, December 22, 2002

I left off last week stating that we had a couple of positives going for us in the short-term only, and that I would be skeptical of any moves up.  We did get a nice up day on Monday, which alleviated the short-term positives I talked about.  That rally quickly failed, and we ended the week pretty much right where we began.  Again, I want to stress that when no edge is present, it doesn't pay to be aggressive in either direction.  It doesn't work every time, but it's the most consistent pattern I've ever seen.

I'm going to be brief this weekend due to the upcoming holidays and the fact that this week will likely be as meaningless as they come longer-term.  As always, you can see current charts of all indicators on the site.

In the S&P 500 futures, for a flat-to-down reporting week, we once again saw a relatively large change in long commitments.  Commercial traders added about 18,500 long contracts but 25,300 short contracts for a net addition to their net short position of nearly 6,800 contracts.  The small speculators added 32,600 long contracts and 19,300 short contracts for a net addition to their net long position of 13,300 contracts.  This is a 20,000 contract swing in a bearish direction.  Over the past 4 weeks, we've seen a 68,000 contract negative swing.  This is the 2nd largest 4-week negative contract adjustment in 16 years, since this data was published.  If we look at the bottom 5% of readings since 1986, meaning the largest negative 4-week swings, the intermediate-term outlook does not look good:

This is somewhat misleading since contract volume in the S&P 500 futures complex has grown exponentially since 1986.  For example, the total number of contracts held (long and short) by commercials and small specs combined in December 1986 was 182,000.  The total in the last reporting period was 1,279,800, a ten-fold increase.  So a 50,000 contract swing in 1986 would have been 27% of total contracts while it would only be 4% of the total now.  If we look at the data this way, as a percentage of the total, our current 68,000 contract negative swing still ranks in the bottom 8% of total readings, and the outlook remains significantly more bearish than random (though not as bearish as the figures above).  The bottom line here is...DANGER!  For the first time in nearly six months, the absolute levels of commercial and small speculator positions is worrisome, to go along with the already-bearish relative levels (i.e. stochastics).  The activity over the past month, during essentially a flat month in the S&P 500, is very bearish.  The commercials have been net sellers while the small speculators have been net buyers, a clear sign of distribution of funds from the "smart money" to the "dumb money".  This is a clear warning sign of lower equity prices over the intermediate- to long-term.

Also troubling is the fact that even though we have seen some heavy selling over the past two weeks (note the relatively oversold TRIN levels on the NYSE and Nasdaq), investor optimism remains high.  The AIM model, which shows the momentum of the four major sentiment surveys, was essentially unchanged during the latest reporting period, and has moved only a few percent despite the selling.  So it's safe to say that traders are SAYING they're bullish, which is bearish enough to a contrarian, but are they actually putting their money where their mouths are?  According to the small speculator positions mentioned above, yes, they are.  Some of our other actual-money indicators, like the put/call ratios, Rydex asset flows and NYSE Members Report don't give as clear a picture. 

The 10-day and 21-day moving averages of the equity and total put/call ratios have bounced off the bullish extremes (bearish to us) they hit in late November/early December and have been climbing higher since.  Currently, they are in neutral territory. 

The Rydex flows have been more positive than they've been in nearly two months, as the assets have slowly been shifting from the bullish extreme (bearish to us) they hit in November.  Currently, all of the ratios I post to the site, in all time frames, are neutral.  However, the bullish flow 10/50 moving average deviation is only about 8% away from levels that have coincided nicely with short- to intermediate-term lows over the past year and the bearish flow deviation is only about 5% away from its respective level.  If we buck the seasonal trend and have a down week, these ratios could become quite constructive.  The shorter-term stochastic and RSI spread are firmly neutral at this point.

In the NYSE Members Report, the specialist short ratio dropped 4% to reach 37% (meaning specialists on the New York Stock Exchange accounted for 37% of all short sales during the reporting week ended 12/06/02 - the latest data available).  The five-year lower 1.5 standard deviation band is around 35%, so the latest reading is relatively low.  While I would have to see a reading well below 35% in order to consider this data bullish, the fact that the public has increased their shorting activity relative to the specialists is something of a positive, and may turn out to be quite bullish if it continues.  As of now, it's neutral.

From the data above, it appears as though traders are not necessarily voting with their wallets to the extent the sentiment surveys would imply.  However, to say that they have been betting on the downside (at least to an extreme) would be false, and thus we cannot consider the current longer-term sentiment situation as anything but bearish.  Therefore, I continue to believe that any large rallies (say 5% - 8%) should be sold and likely shorted if the opportunity presents itself.  We remain in a bear market until proven otherwise, and excessive optimism like we've seen recently in the context of a bear market begs to be sold.  In the short-term (the period covering the next week), essentially all of our indicators applicable over that time frame are neutral, giving us no edge with which to work.  However, I would continue to refer you to the Christmas day (and New Year's day) bias as laid out in the Research section, or the December 18th daily commentary.  Thursday and Friday of this coming week will have a clear positive bias working for them, and I believe that must be respected.  Until then, I don't see a clear edge either way.

 - Jason Goepfert

Disclosure:  long QQQ calls, long QQQ puts

This disclosure is not intended as trading advice in any form.  It is meant as a note to subscribers that I have a position directly affected by my market outlook.  Although I take great pains to remain objective in my commentaries, I believe it is only fair that readers should know that I have taken positions in accordance with my market outlook.