Tuesday, April 29, 2003 8:16 PM EST
In the portfolio change I sent out this morning, I mentioned that I have received a large amount of email asking me what it would take to turn me bullish in here. In order to answer all the emails in one fell swoop, let me outline what it would take in four easy steps:
1. Let's break the downtrend line first before getting all lathered up.
2. OK, now that we've finally broken the downtrend, we need to actually exceed a prior high (the straight black line is the hypothetical path of the S&P 500).
3. So far, so good. Now, on the next swing lower (there WILL be one), we must hold above the prior lows. At this point, the market becomes neutral - we are STILL not in a new bull market as far as I am concerned. That only comes after step 4. As of this step, we're in a trading range at best.
4. FINALLY! We have exceeded the prior higher high, and we can now say with some confidence that we have entered a new bull phase.
The above sequence of events, whether it happens now or some point in the future at lower levels, is what I require before even CONSIDERING that we are in a bull market.
I'm quite confused by those who say that I am "top picking" by being bearish here. I am simply following the larger trend, and that is unequivocally down. I am not going to gamble that maybe, perhaps, if we cross our fingers, we are in a new bull market. That may very well be the case, but until the odds are on my side, I do not see the sense in being a bear market bottom picker. Perhaps if we had seen the type of sentiment one would expect to see at the end of a bubble of massive proportions, I would be more open to the long-term bull case. But no long-term sentiment measures that I follow, published or otherwise, is anywhere near where other multi-year bull moves have began. Sure, this time could be exceptional. But please, let's try to put the odds in our favor.
This weekend, I mentioned that our Down Pressure indicators were on the verge of giving a positive indication for the market, as it would take only a mild down day on Monday in order to push them into oversold territory. We've now reversed that situation, as even a flat day tomorrow will force both the S&P 500 and NDX indicators into overbought. If we get a relatively positive day, similar to today, then the indicators will be grossly overbought tomorrow. When we are not in the immediate aftermath of an intermediate-term low, such overbought readings signify market conditions that are almost never sustainable. This suggests that another up day tomorrow would likely be followed by weakness over the ensuing 1-3 days with a high degree of consistency. All of our other, longer-term breadth measurements (e.g. advance/declines, up volume, TRIN, cumulative TICKS) remain in various stages of overbought, mostly grossly so, as I outlined this past weekend.
We all know market breadth is overbought. While that is certainly a concern, it is not my biggest one. Most troubling is that this overbought breadth is being warmly accepted by investors, and they have climbed on the bandwagon. Once again this week, action in QQQ (Nasdaq 100) options is skewing the equity put/call ratio. The traditional equity ratio recorded a reading of 0.80, which is quite high and would normally be a bullish indication, particularly on a day on which the major indices closed higher. However, if we back out what are essentially index options in the guise of a stock, the equity ratio drops to 0.56. The 10-day average of the non-QQQ equity p/c ratio is now an extremely low 0.55, one of the lowest ratios in years and on a par with what has been seen at prior market peaks.
In the Rydex mutual fund complex, our 3-month stochastic indicator has reached extreme overbought territory over 0.90 for only the second time in its history (dating back to 2000). The only other time to exceed this threshold was late November 2002, which obviously lead to declining prices over the ensuing weeks. We have to go back to January 30th, 2001 for the next highest reading of 0.87, and that marked almost the exact peak before the descent into the Spring of that year. This confirms the reading from our Beta Chase Index, which has a good chance of popping over 3.0 with today's numbers. This tells us that not only have these traders been shifting aggressively into the long-side index funds, they have also been putting a lot of money into the speculative sector funds. These two indicators, particularly the stochastic, have had an uncanny ability to pinpoint short- to intermediate-term market peaks within a few days for the last few years. Whether that pattern will continue is of course the question, and my stance is always that it will until proven otherwise. Like I said above, let's actually break the downtrend before thinking about shifting into bull-market mentality.
Whenever we get to an important inflection point in the market, I like to go back to my notebook, where I try to record my personal thoughts each trading day. I went back to a couple of important important tops and looked at my comments (these are exactly as I have written in my notebook):
January 13th, 2003: "Jeez, lots of bullish talk and it makes so much sense. Mkt shrugging off bad news like crazy, keeps going higher."
January 4th, 2002: "Pretty much everything I hear on TV or read right now is very bullish - that the economy is turning around, companies are not pre-announcing, positive January effect, etc. That was the same two weeks ago b/4 the S&P dropped 30 points. After the drop, then everything was negative - that the economy was not turning as fast as people thought, that semi's were in the toilet, etc. YOU MUST LOOK AT FADING POPULAR OPINION. Although that is the basis of what I try to do, I still find it difficult to take a substantial position when everyone else is screaming for the other direction. TREND CHANGES COME WHEN EVERYONE LEASTS EXPECTS IT."
These two days were the DAY the market peaked for that move. As you can see, the news and analysis is always positive at the top. I'm not suggesting today was a multi-month top - I have no idea if that's the case or not. My point is that when you cannot figure out a catalyst for the market to move lower, it will often find one for you.
When we step back and view our situation objectively, four things cannot be denied:
1. This is a bear market.
2. The downtrend line has not been broken.
3. The market is overbought by almost any measure, especially breadth.
4. Sentiment is extremely optimistic.
The odds are not with intermediate-term long-side positions. Until we are in a confirmed uptrend, as outlined above, I will continue to sell these retracements.
- Jason Goepfert
Disclosure: long OEX puts
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.
© 2003 Sundial Capital Research, Inc. All Rights Reserved.