Mar 31, 2003

http://www.sentimentrader.com

Thursday, April 3, 2003 10:45 PM EST

In today's intraday note, I made mention that the session so far appeared to be very healthy. The short-term overbought sentiment condition we entered shortly after the gap up open yesterday was wearing off, and the market was holding strong. Usually, the resolution of such a situation is another push higher, to challenge recent highs. Both the S&P and NDX did make another push towards the highs in the afternoon, but it ultimately failed and closed near the lows. I've been suggesting that I would not be looking too aggressively on the short side until more weakness was evident, so this may be the beginning of that opportunity.

Adding some credence to the short side is the fact that some of our longer-term breadth measurements are hovering very near overbought territory. A couple of my favorite measures are the 21-day moving averages of the up issues ratio (a.k.a. advance/decline line) and up volume ratio. I use 21 days simply because it equates to an average trading month. I haven't posted charts of these two indicators recently, so here they are:

We can see that both of them are near their historical overbought levels. The 10-day charts that are posted to the site are also close to overbought, and if we happen to have an up market both Friday and Monday, then they will very likely become extremely overbought, due to the figures that we'll be dropping from the averages.

I also calculate an indicator which combines the two 21-day ratios discussed above. This combined indicator oscillates around 1.0, with oversold readings near 0.90 and overbought near 1.10. When we consider these readings in the context of the dominant weekly trend, they become very effective at pinpointing intermediate-term opportunities. Let's take a look at an uptrend first, from 1997-1999.

The green arrows identify those times when the oscillator formed a trough beneath the oversold area of 0.90. Obviously, it coincided quite well with what turned out to be very high reward / low risk buying opportunities.

Now let's take a look at the opposite market environment, the steady decline from 2000-present:

Here the red arrows pinpoint those times when the oscillator formed a peak near the 1.10 overbought area. Once again, it identified very good risk/reward opportunities, only this time on the short side. Out of the 13 occurrences, the S&P enjoyed a subsequent rally of over 5% over the next month only three times - after the panic lows in September 2001 and October 2002, and the odd little spike higher in May 2001. Needless to say, when we're approaching a situation where the market has a 77% failure rate, we should take note. What makes this especially troubling is that two of the occurrences happened after we saw true panic readings across a broad array of our sentiment measures. This time around, however, we saw only a minimal number of our indicators flash readings that could be considered anywhere near extreme. This is notable because panic lows flush out weak holders of stock. Those buying shares from the panicked sellers are typically of a steadier hand, and don't sell immediately after their positions show a profit. This allows the market to steadily rise for several weeks or months. However, when we do not see a panic low, just something that could be considered mediocre at best, then we still have a base of stockholders that get anxious to sell when the market begins a significant rally. This puts a cap on further advances, and it is the biggest negative facing the market right now (from a sentiment perspective).

Adding to the overbought breadth readings are the Down Pressure indicators for the S&P 500 and Nasdaq 100. These measure the proportion of points gained or lost (and the volume flowing into those up or down securities) for the components of both indexes. The lower the indicator, the less selling pressure there is. Since the indicators posted to the site are a three-day average, by the time they reach a low (overbought) reading, we have typically seen several consecutive up days, and it is a signal that it is time for the market to take a rest, at least. As of today's close, the indicators for both the S&P and NDX have entered overbought territory. It has been quite unusual for the markets to retain their upward momentum when such readings have been reached recently, and more often than not weakness follows. Except for the period immediately following the recovery from the October lows, no more than one more up day has followed these overbought readings before tradable weakness was seen. This suggests that if we do have another up day tomorrow, then there is a relatively high probability of seeing weakness very early next week.

This weekend, I said that a continuation of choppy market conditions would likely serve to push the VIX Fear Premium lower. That has indeed happened, as that indicator has dropped 3 points in the past four days. This is normal and it shouldn't become worrisome until we get closer to the zero line, which is still a long ways off. This would tell us that options traders are not pricing in any additional volatility than what we have seen over the previous 30 days, which is a sign of complacency that usually leads to a price decline. While we're still a ways away from that zero point, we're quickly approaching the point we reached in mid-January. I don't think this is troublesome yet, and probably won't be for several more days at least, but I wanted to bring it to your attention as something to keep your eye on during the coming week.

The Rydex mutual fund family saw quite a large swing in assets after yesterday's performance, and it was enough to swing our short-term RSI spread indicator back to overbought territory with a reading of +45. While not truly extreme, the sudden shift in asset momentum from the bearish funds to bullish is bothersome enough to warrant a mention. As you know, I calculate a bull and bear ratio for these funds. Each ratio is calculated by computing the percentage of assets that are in the long funds versus those in the short funds and money market, weighted by the leverage that each fund employs. This gives us an excellent look at the psychology behind the movements of money between the various funds. The chart below is a simple spread between the bullish ratio and bearish ratio. If the green area is above 0%, then there is a greater percentage of assets in the long funds than the short funds (again, weighted by leverage). Conversely, if the green area is below 0%, then the short funds make up a greater percentage of assets. The pink highlights show those instances where the green area is above 0% - where the bull funds make up a greater percentage of assets than the bear funds during the last year (there were a couple of one- or two-day wonders in there which I did not try to highlight).

We can plainly see that such instances have not been conducive to higher equities prices. In fact, it was very rare for the market to make any significant headway after such an asset shift. This is not entirely surprising, as these Rydex fund timers are notoriously late to catch a trend, so by the time they recognize it and shift their money around to take advantage, the trend is about to change. As of yesterday's close (the most recent data available), these ratios have once again become "inverted" - the spread is above 0%. Obviously, this is not encouraging.

I have been saying for over a week now that I thought the most likely scenario for the foreseeable future is a trading-range environment. I still feel that way, and since we are approaching the upper end of the trading range, and are becoming overbought, my preference is beginning to tilt to the short side. The breadth of the market is becoming overbought, and another positive day or two will should make it grossly so. The optimism surrounding such positive breadth is quickly becoming noticeable as well. We remain in a longer-term downtrend, so those factors taken together suggest that the risk/reward is beginning to skew to the short side.

Disclosure: no positions

This disclosure is not intended as trading advice in any form. It is meant as a note to subscribers that the author may have a position directly affected by the market outlook reflected in the commentary. Although the author takes great pains to remain objective in any commentaries, it is only fair that readers should know that the author may have taken positions in accordance with his market outlook. Positions can and do change at any time, without notice to the reader.

Tuesday, April 1, 2003 10:20 PM EST

I know that some of you detest when I send out these types of comments (I have the emails to prove it), and you pay me to help find you an edge, but I have to say it - there is just not much going on at the moment in the world of sentiment, at least not far from what was detailed in this past weekend's commentary. In looking over all of our indicators and models, published and unpublished, I would have to really stretch in order to come up with something that I think could give us an edge, on any time frame and in either direction. And in stretching like that, I think there's more of a probability of "discovering" something that isn't really there, than there is of finding an item that's truly useful. We're simply dead-stuck neutral.

This weekend, I mentioned what I thought was the most likely course of action for equities based on the neutral and mixed readings from the sentiment tools available to us. My thought was that we would see something like last October, where we would have limited moves higher and lower, but remain relatively unchanged after several weeks. I thought we would also see a pickup in volatility, as last week was one of the least volatile periods in three years. It's only been two days, but so far we've seen the S&P travel nearly 40 points, and yet we're still within 0.6% of where we closed on Friday (anyone wondering why we didn't see the widely anticipated quarter-end markup in the broader market, please see last Wednesday's daily comment). I think more of this type of action is what we have to look forward to, barring a major development in the war of course, so the plan remains the same - short time frames with an emphasis on oscillator-type indicators and less aggression on breakout/breakdown strategies.

Once we get something of a sustained trend in either direction, we should see a high-odds opportunity develop, but I'm just not seeing ANY advantage right now sentiment-wise. My preference for longer-term positions (out at least several weeks) has been to the long side, as long as the speculation from the recent run-up was being expunged, and we remained above 830 on the S&P, but I have not seen the type of activity that would get me to risk capital just yet. With war developments having its way with the capital markets, there's a very good chance that we could see another major move develop without any real sentimental, technical or fundamental support, but gauging the timing of that is exceedingly difficult unless there is some obvious change in the war situation. Until such time as we develop a solid edge, or the war makes some decisions for us, patience remains the watchword.

- Jason Goepfert

Disclosure: no positions