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Thursday, June 12, 2003  9:45 PM EST

Much has been made of the latest readings from the Investor’s Intelligence sentiment survey conducted by Chartcraft, Inc.  You probably know by now that the percentage of respondents who said they are bearish on the market dropped to 16.3%.  This is the lowest reading since March 1987, and in the bottom 8% of all readings since 1969. 

In the history of the survey, the bearish percentage shows a mean of 33%, with a standard deviation of 11%.  So, we should expect to see most readings (68%) between 22% and 44%.  A reading of 16.3% is a bit more than 1.5 standard deviations from the mean, which makes it relatively rare historically.  I went back over the entire history of the survey and took a good look at each of the other times the survey reported such a low level of bears, what lead up to them and what happened afterward.

I was most interested in seeing how much of a rally it took off of an intermediate-term low to garner enough optimism that only 16.5% of respondents would say they are bearish.  After that, I checked to see how long it took until the bearish percentage went back to “normal”, meaning back above 22%.  Then I wanted to know how long it took before the market suffered at least a 5% decline, and what kind of drawdown (loss) one would have suffered had one bought the S&P 500 cash index after seeing such a low amount of bears.  After all, with only 16% bears, who would be left to buy, and how much could the market rally in the face of such optimism?  Also, I wanted to check to see how severe the subsequent corrections were after seeing so few bears.

The table below lays out this information.

KEY:

1. Date of the first reading with the bearish percentage at 16.5% or below.

2. The bullish percentage at the time of the low bearish percentage reading.

3. The number of consecutive weeks with the bearish percentage under 22%.  This extends from the date of the initial reading under 16.5% through the week where the bearish percentage first went back above 22%.

4. The amount the S&P 500 rallied from an intermediate-term low to the time the survey first reported fewer than 16.5% bears.

5. The number of days the market rallied from an intermediate-term low to the time the survey first reported fewer than 16.5% bears.

6. The amount the market rose from the time fewer than 16.5% bears were reported until the market began a decline of at least 5%.  This can be considered the drawdown if one had sold short the S&P 500 when fewer than 16.5% bears were first recorded.

7. The number of days the market rallied from the time fewer than 16.5% bears were reported until the market began a decline of at least 5%.

8. The amount the S&P 500 declined after forming an intermediate-term high (in this case, defined simply as a decline of at least 5%).

9. The number of days the market corrected after forming an intermediate-term high.

After looking at each occurrence in detail, here are my conclusions:

*  It is rare to see the bears pick right back up again.  In fact, in only one instance (December 1975) did the bearish percentage pop back above 22% the week after showing a reading under 16.5%.  The average streak of subsequent readings under 22% is 15 weeks.  If we remove the “outlier” of 65 weeks, then the average drops to 10 weeks.

*  From January 1976 through March 1977, the number of bears didn’t make it above 22% even once.  This is an entire YEAR of “extreme” bullish sentiment, as the market chopped around in a large trading range.

*  We’re right about average when looking at how much the market rallied until the bearish percentage dropped so low.  However, we’re quite a bit below average when considering length of time.  So, it appears as though these newsletter writers are quicker on the draw when concluding that the market will continue higher than they have been in the past.  There were four other instances where it took them twice as long as now (in terms of days) to conclude that the rally was for real.

*  THIS IS NOT A GOOD TIMING MECHANISM!  Only twice did the market top out soon after seeing such few bears.  In ALL cases, one would have suffered a drawdown, ranging from 2% to 21%.

*  The average length of time it took before the market suffered a decline of at least 5% was 49 days.  This is nearly 2 ½ months from the time the bears first dropped under 16.5%.

*  The average correction after such high optimism was not very severe.  If we take out the “outlier” from December 1972, then the average decline was 9% over the course of 41 days.  But remember, it took an average of 49 days and a 9% drawdown just to get there!

*  The closest comparison to our current situation is probably 02/07/75.  At that time, the market had bottomed after the 1973/1974 bear market, and had just rallied past the prior weekly swing high set in November 1974.  As you can see from the table, the market then rallied for another month (and another 10%) before suffering a swift 8% pullback over the course of a few weeks.  It should be noted that after that brief correction, the market took off and rallied into the late summer, when we once again saw a very low amount of bears, this time leading to a more severe correction almost immediately.

If we try to apply these precedents to our current situation, it would suggest that the market may make it another 8% or so before undergoing a correction of at least 5%.  This gives us a target of about 1075 on the S&P 500, to be reached by mid-August.  PLEASE NOTE:  I do NOT recommend trading by these guidelines, as they are for demonstration purposes only, kind of an exercise to see what’s possible based on precedent.  Each moment in the market is unique, and there’s no reason to expect that the market WILL conform to the average of 13 past occurrences.

Obviously, this rally off of the March lows has been different from the prior bear-market rallies we had seen.  I was not willing to bank on that until we at least broke the weekly downtrend line and exceeded a prior weekly swing high, which we have accomplished (as of 955 on the S&P 500).  Now that price has confirmed what some of our longer-term indicators have been saying, I would say that we are looking at better-than-even odds that we are not about to roll over, and in fact may lurch higher during the summer.  I am basing this proposition on the study above, as well as the discussion of specialist shorting I outlined in the May 26^th weekly commentary (check the archives for reference), and the breadth thrust that we had seen only three other times in the past 40 years (see the June 4^th daily commentary in the archives).  The strength the market has shown cannot be minimized, and the more we see these historic “overbought” readings, the more it appears they are not necessarily bearish, but are indeed decent indications that we may be in only the beginning of a much more important rise.

With that underlying assumption, my preference turns to trying to find low-risk opportunities on the long side.  I cannot find one at the moment, as nearly everything I follow is suggesting that the long side is very high-risk right now.  But, it has been high-risk for a couple of months and many percentage points, so does it make sense to close our eyes and buy blindly?  That’s not my style, and I don’t think it’s at all prudent.  Public speculation by traders who have a good track record of being wrong is extremely high at the moment, and I find it hard to trade alongside them when we’re already up by 25%.  Unfortunately, many of our sentiment measures have not been around long enough to know how these types of traders would have reacted in prior markets, so that does present a difficulty right now.  As hard as it may be to imagine, it appears as though if Friday’s high is taken out and held, then there may be enough “oomph” to get us to the next layer of resistance from 1050 – 1150.  Along with millions of other traders, I will be using 1008 on the S&P as my line in the sand – bullish above, and bearish below.

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.

Tuesday, June 10, 2003  9:07 PM EST

There isn’t much to go over tonight that is different from the weekend commentary, as the broader market is basically unchanged after two days of flip-flopping. 

This weekend, I mentioned I study I did regarding potential reversal days similar to what we experienced on Friday.  According to that study, there is now about a 33% chance that Friday’s high will be exceeded sometime this week.  If we close at 982 or below on Wednesday, then the study would suggest that there is only a 9% chance that Friday’s high would be exceeded sometime later this week.   

Until the closing ½ hour, we were forming a very tight range in the S&P 500.  The closing spurt “ruined” the ultra-narrow-range aspect of the day, but it was still a fairly narrow range for the NDX.  Using QQQ as a proxy, today was an inside day (lower high and higher low than yesterday), and it also had the narrowest range of any other day over the past 7 days.  During the past three years, such days have been followed by an outside day (higher high and lower low than the day before) about 29% of the time.  This compares to the chance of seeing this on any random day of 12%.  Also, there is a slight increase in the chance of seeing a very wide range day after days such as this.  What this tells us is that there is a decent chance that we will see increased volatility tomorrow, and a much better than random chance at seeing both today’s high and today’s low being taken out.  This doesn’t tell us what DIRECTION the market should move, only that it should move, and it could be large. 

The STEM.MR model, after entering strong positive territory at the close yesterday, is back to neutral at 27%.  That goes along with our other intraday indicators, many of which had entered oversold by the close yesterday.  While we don’t have a confluence of short-term indicators back in negative territory just yet, much more of a rally tomorrow would likely get us there.  This suggests that additional upside attempts may not have the juice to get over what would be stiff resistance at Friday’s highs.  As a reminder, you can see intraday updates of the STEM.MR model and the other intraday indicators twice each day at this link:  http://www.sentimentrader.com/subscriber/intraday_charts.htm 

At this point, I continue to favor the short side, at least unless Friday’s high is taken out (and it holds), which would be a rare and impressive feat.  If Friday’s high is broken decisively, I see no point in attempting to pick another top unless we trade back through it again on the downside.

- 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.