Big-Money Bulls

Bottom Line: Bearish sentiment in the magazine’s semi-annual poll is running low among the “smart-money” crowd, but their record isn’t exactly stellar.

Barron's weekly magazine runs a semiannual poll of money managers, the latest version of which was released this weekend. Over the years, the poll has included fewer managers (currently about 85), with less money under management, and with around 16,000 mutual funds and hedge funds in existence today, I don’t think a sample of 85 could be considered representative. Still, it gives us a glimpse into the institutional mindset.

The latest poll is interesting because it showed one of the lowest numbers of bearish respondents in the past six years. In fact, for the first time since at least 1999, none of the money managers considered themselves “very bearish”, and on average the bulls expect the S&P 500 to close at 1212 at the end of the year, a rally of around 7% from where the index was when these managers were filling out their surveys. While the specific stocks these managers recommend tend to do better than the ones they don’t like, their overall market outlook generally leaves something to be desired.

The charts below show the comparison of the big money's predictions at where the S&P would be six months from now (on average) to the actual outcome (some of this had to be estimated due to the methodology of the survey). The second chart shows the percentage of bullish respondents versus bearish respondents.

During 1999, the big money actually UNDER-estimated the power of the bull market, as their guesses were consistently below where the S&P ended up closing. Once the bear began, however, the money managers did nothing but OVER-estimate the market potential, often by 10% or more. In the second chart, we can see that the two times the managers were the most pessimistic – May 1999 and October 2002 – were the times the market did very well afterwards. This is not a group that I would normally look to "fade", or take the other side of, but the limited history we have for them points to the suggestion that as a group, these managers are probably best viewed as something of a contrary indicator. When a contrary indicator is showing 4% of respondents as very bullish, 57% bullish, 12% bearish and 0% very bearish, I become a little nervous from the long side.

Bottom Line: The Nasdaq Composite fell below its 200-day average on Friday for the first time in over a year. How the next week unfolds should give us a clue as to its prospects over the intermediate-term.

There was some worry this weekend concerning the fact that the Nasdaq Composite sliced through its 200-day moving average on Friday for the first time since the rally began last March. There is no magic to the 200-day average (a typical year has 252 trading days, not 200), but it seems to have caught on as the long-term moving average of record, and most people have it on their charts simply because everyone else does too. Some people use it as a very basic trend-following indicator in that they want to be long if price is above the average and out of the market (or short) if below. Certainly by doing so, these traders would most likely catch most of the very long-term uptrends and miss most of the severe downtrends.

If we look at how the Nasdaq performed after it first crossed its 200-day moving average to the downside, its future performance out to one year later was slightly better than average. However, I think there is a better way to view it that may help us to determine if this will be one of those times when sellers would be “whipsawed” as we reverse higher, or if this crossing of the long-term average is a foreboding signal of more selling to come. The table below shows how the Nasdaq performed the given number of days after dropping below its 200-day average after having traded above it, for the period 1971 - present. I have required that the index trade above the average for at least 21 consecutive trading days prior to dropping below, to avoid counting the times when it simply chopped around it. The table is separated by those times the Nasdaq was trading lower 5 days after first crossing below the 200-day average, and those times it was trading higher.

Nasdaq Crossing the 200-day Barrier Future Performance the Given Days Later 1971 - 2004
	10 Days Later	30 Days Later	60 Days Later	90 Days Later	120 Days Later	250 Days Later
When the index was negative after 5 days (15 instances)…
Avg Ret	-5.2%	-4.2%	-2.9%	-0.7%	3.8%	9.3%
% Pos	13%	40%	53%	53%	60%	67%
When the index was positive after 5 days (14 instances)…
Avg Ret	2.9%	4.4%	10.7%	12.8%	13.7%	22.5%
% Pos	86%	93%	93%	86%	93%	79%

Out of the 15 times the Nasdaq was lower after 5 days, the average return was minus 3.4%. That includes a -20% performance from 1987, and without that data point the return “improves” to minus 2.2%. Of the 14 occurrences when the Nasdaq was positive after 5 days, the average return was 1.9%.

Of those that were negative after 5 days, 13 out of 15 remained negative after 10 days, meaning only two times was the Nasdaq able to scratch back to at least breakeven by one week later. After 90 days, the average return was still negative, though the Nasdaq was actually positive 8 out of 15 times. The average loss was 16% compared to an average gain of 12%.

Of those that were positive after 5 days, 12 out of 14 remained positive after 10 days. In fact, even after 90 days had passed, there were still 12 that were positive, and the average return was an impressive 12.8%. The two losses averaged 5.5%, while the 12 winners averaged 16%. This tells us that after those times the Nasdaq quickly reversed course from a “fakeout” move below its 200-day average, it brought in consistent buying pressure and often marked a longer-term low.

What I take away from this is that if the Composite is above 1920 this coming Friday, it bodes well for the longer-term health of that sector of the market as it suggests that the break on Friday was a fakeout. On the other hand, if we continue to decline and show a loss for the week, that tells us less than if the market would have risen, but overall it has negative connotations, particularly for the next few months.

With the heralded “sell in May and go away” negative seasonality influence now upon us, I thought I would also check to see if any of these first crosses below the 200-day average occurred in April or May, and if it made a difference to the bottom line. Out of the 29 total occurrences, only two occurred in either month, both April, and in fact the Nasdaq performed admirably up to six months later, bucking the bad rap that the summer months tend to get.

Bottom Line: How the market reacts to tomorrow’s rate decision will likely tell us very little about the market’s prospects for the future.

While most attention will be focused on how the market reacts to the Fed’s action (or inaction) tomorrow, the initial reaction to their decision may not tell us much about what is in store over the next few weeks. Looking at all Fed meetings since 1996, there is not much of a correlation between how the day of the Fed meeting closes and how the S&P performs over the ensuing weeks.

When the day of a Fed decision (whether they raised or lowered rates, or left them unchanged) disagreed with the market and the day ended down, there was usually an immediate snap-back, as the next day was higher 74% of the time, with an average return of 0.7%. However, the day after that was up only 47% of the time, and showed a slightly negative average return. Going out further, the market seemed to vacillate often, and there was no clear direction.

When Fed day closed positively, then the next day was up 55% of the time, with an average return of 0.0%. This neutral behavior lasted up to six months later, as once again there was no clear bias.

I think it’s important to note that comparing market reactions after economic events are very often fruitless. While a rate hike might be interpreted as bullish one month, the next month it could be exactly the opposite. By forgetting about the Fed’s preference and just looking at market performance, it becomes evident that there is little predictive power in the immediate market reaction to these Fed decisions. About the only thing I would point out as having any consistency is that if Tuesday closes negatively, there is a decent chance we could see at least a very short-term reversal on Wednesday.

Today’s rebound took us right back into that 1120ish area I’ve been mentioning for weeks. The breakdown from that level is troublesome, but if we can regain and hold it over the next couple of days, I think the larger structure remains positive and I would see no reason to panic and sell longer-term positions. If, however, we fail somewhere around here and head back down to take out the recent lows, a visit of the March lows would be the obvious next stop. Our shorter-term measures are now only slightly stretched after today’s rally, but the readings they reached late last week suggest there is more upside to come. Again, if we are not able to muster higher prices, we would be seeing market behavior associated with larger downtrends, not uptrends, and a visit and (probable) break of the March lows would be the most likely next move.

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.