Sunday, March 23, 2003
I don’t have a
scheduled commentary this weekend, so this note will not follow the usual
structure, but I want to touch on a few developments that I think warrant
our attention before the trading week begins.
COMMITMENTS OF TRADERS – We saw some very large and unusual swings in the positions of commercial traders and small speculators in the most recent report for both the large S&P 500 futures contract and the e-mini, and they give conflicting signals. In the large contract, commercial traders have become the least net short they have been since May 2000 – right before the last kick higher of the bull market. This change in their net position did not come about from short covering, as most of the change was accounted for by a large addition to long positions. At the same time the commercials were becoming significantly longer, the small speculators were shorting heavily, and they are now the least net long they have been in nearly two years. These developments have pushed both the one-year and three-month Futures Balance Matrix to 100, the most bullish possible. Remember, the F.B.M. looks at the momentum of net positions of commercials vs. small specs, and a high number means that the momentum clearly rests with the commercials. A reading of 100 is the maximum value, and that has been a bullish sign in the past. A few factors should temper the bullishness of these readings, however. First, the S&P has already rallied 3.5% from Tuesday’s close, which is when these positions were reported, so there is a high likelihood that they have changed substantially already. Second, we were approaching the expiration of the contracts during this reporting period. As I’ve shown several times in the past, futures expiration has a large impact on the changes in these positions not just during expiration itself, but also the week prior to expiration. Therefore, that event likely influenced these changes to some degree. Third, action in the e-mini S&P contract was very disturbing. As I stated last week, commercial traders in this contract were quite net long, while small specs remained net short. With the rally going into last Tuesday, the commercials covered a number of longs but added a huge number of short contracts, while the small specs were covering shorts and adding a large number of long contracts. The small specs are now the net longest they have EVER been in this contract, while the commercials are the 2nd net shortest they have been, with November 2001 being the only time they were more net short. As I have been saying, the e-mini has not been an effective indicator until only the last six months or so, so that should diminish the weight given those positions. Also, they change greatly on a week-to-week basis, so I think the time frame in which they could be effective is shorter than that of the large contract. The huge change in the e-mini suggests that weakness should be expected in the short-term, as the commercials have been shorting this rally while the marginal small specs have been jumping in whole-hog. However, from the action in the large contract, any weakness looks like it may be temporary, as those positions are going in a direction that normally results in more strength than weakness in the intermediate-term.
RYDEX RATIOS – Very troubling developments here, as there has been a $1.5 billion dollar flow out of the short funds (particularly the leveraged short funds) and into the long funds over the past two weeks. This is 33% of total assets in the index funds plus money market, and is the largest two-week net movement of funds in the three years since the leveraged funds were created. As I mentioned last week, the RSI spread hit +100 for the first time in its history, and that remains the case as of Friday’s close. For the past four days, the short-term momentum of the bull ratio has been 100, while that of the bear ratio has been 0. Also, our proprietary Beta Chase Index hit 7.02 on Friday, which is a new three-year record. This means that the highest beta funds in the Rydex complex have an average relative strength more than seven times that of the “safe” funds that show a low correlation to broader market movements. When traders are confident of further upside in the market, they shift their money to those funds which would benefit the most from that upside – the funds with the highest beta. These asset shifts show that there has been a tremendous change in the psychology of these traders, and they are now panicking in trying to get long for a continuation of this move higher.
PUT/CALL RATIOS – The readings here are not quite as extreme, and as I have said, they were likely low this week because it was expiration and the market was up. Put/call ratios tend to be low during such environments, because traders can make a fortune if the trend continues. In any event, both the 10-day and 21-day moving averages of the equity p/c ratio have now approached or exceeded the lower trendlines they have formed over the past year. This tells us there has been a consistent bias of call volume over put volume, which is a bearish sign. The de-trended equity p/c ratio, which you can also see on the site, has now breached its standard deviation band. While there is some room for it to become even more extreme, this type of activity has lead to an imminent top with only one exception over the past two years.
BREADTH – The 10-day and 21-day advance/decline line and up volume ratio are now at the upper end of neutral to lower end of overbought. We’ll be dropping negative numbers from these ratios for the next three days (including very large ones on Monday), so with another positive day in the market, these ratios will likely become firmly overbought. While it’s certainly possible for the market to continue to rally once these levels are reached, it becomes less and less likely that any further move would be sustainable. Most remarkable, the 10-day TRIN will almost certainly enter overbought territory tomorrow. The extremely high reading over 5.0 we saw on March 10th will be dropping off the average, so it will dip into overbought territory with any reading below 2.50. Taken in a vacuum, there’s over a 99% chance of that happening (meaning a reading under 2.50), so it’s quite likely. If we get another positive day on Monday, with a TRIN under 0.60, then the 10-day average would drop to 0.76 which is extremely overbought. The Nasdaq TRIN is already in overbought territory, and the NYSE reading will most likely join it tomorrow. Our cumulative TICK measures are almost uniformly overbought across every time frame. The intraday cumulative TICKs posted to the site are 13-period moving averages (covering one full trading day). I track several others which look at the past 39 and 65 periods (three days and five days, respectively), and each of those are at a point that has corresponded well to market peaks shortly thereafter.
These developments are what I have been looking for ever since I said I was bullish above S&P 830 UNTIL we became overbought. We are now overbought, another positive day on Monday would probably make us grossly so, and we are STILL in a longer-term downtrend. Therefore, I will be concentrating on short-term short setups going forward, provided we don’t see some spectacularly good news geopolitically. A major war development will move the market regardless of overbought or oversold levels, so that must be factored into your risk profile. As long as we remain above that 830 level on the S&P, I think the longer-term health of the market looks positive. The more I study the action since the low on March 12th, the more I feel that it can serve as a longer-term low. We didn’t see many of the types of readings normally associated with a low of this magnitude, but the action since that point has been nothing but positive. If we do get a downside retracement over the coming days, I would view it as an opportunity to possibly initiate longer-term long positions (again, provided we stay above 830 on the S&P).
- Jason Goepfert
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.
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