Continuing to be Wary of Breakouts
Monday, June 28th, 2004 9:15pm EST
Dollar Commitments
Bottom Line: Looking at the total dollar commitment of large traders and small speculators, we can get a little better idea of how each group is positioning themselves. The current data, though affected to a great degree by expiration, paints a mildly bearish picture.
Over the past year or so, I have expressed my reservations about reading too much into the Commitments of Traders data, which shows futures contract positions for large and small(er) traders. The increasing use of the e-mini contract has caused all sorts of distortions in the data, and it has not had nearly the “readability” that it had prior to 2003.
Still, I get several questions each week about the data, and this weekend was more heavy than usual, due to a relatively large change in the positions for both commercial (large) traders and small speculators. I’ve shown before how expiration weeks account for most of the large position changes, and this week was no exception, but still I thought I would show another view of the data that I haven’t shown in a while.
The charts below show the total dollar value of all net positions for both commercial traders and small speculators. The amounts are a combination of all the main index contracts – the full and e-mini S&P 500, the full and e-mini Nasdaq 100 and the full and e-mini Dow contract. Each of the net positions was multiplied by the appropriate amount to come up with a dollar amount. For example, if commercial traders are net long 1,000 full S&P 500 contracts, then it translates into the following dollar amount if the S&P 500 is currently at 1135:
Dollar amount = # contracts x multiplier x index value
Dollar amount = 1,000 x $250 x 1135 = $283,750,000
So, commercial traders would be long the equivalent of $284 million in stock. The chart below plots a sum of the total dollar value that commercials (green line) and small specs (red line) are net long or net short in the index futures:
The wild activity in 2000 really skewed the figures, as commercial traders were net short an enormous amount of index futures, while small speculators were on the other side of a large part of it.
To better see the interaction between the two groups of traders, the chart below shows only the past few years, and commercial traders (left scale) and small speculators (right scale) are shown on separate scales. Because they are separate scales, please be careful when looking at the chart. While it looks like the two groups of traders “switched sides” at some of the market turning points, that is just a function of the scales being off. The chart above is accurate and the one below is misleading, but it more clearly shows the interaction between the traders.
From this chart, we can see how each set of traders reacted to the market. At each of the major lows, we see commercial traders greatly reducing their net short positions – almost becoming net long in October 2002 and March 2003 – while small speculators were abandoning their positions. Over the past year, we can see how difficult it has become to decipher these moves.
What we can see is that commercial traders, who had close to their least amount of money bet on the short side as recently as early June, have now moved back to one of their most defensive positions of the past few years. They are now short about $14 billion worth of index futures (again, this is spread among S&P, Nasdaq and Dow futures, both full and e-mini contracts). Small speculators, on the other hand, are net long about $20 billion of index futures, though that is well below the $25 billion to $30 billion they were long at some of the prior market peaks.
While there may still be some value in the COT data by looking at it this way, I continue to be leery of reading too much into these position changes. Currently the data looks as though it may be mildly bearish for the market, due to the relatively large short position held by commercials, but it is not yet intriguing enough to suggest that it is a reason in and of itself to be negative on the market’s prospects.
Conclusion
The Commitments of Traders data I would consider a very mild negative, but there are a few other things that are more troubling. Our R.O.B.O. put/call ratio dropped to 0.44 last week, the lowest since late April. The SPY and QQQ Liquidity Premiums are extremely low, showing no rush at all by traders for the relative “safety” of those trading vehicles. Some of our Rydex measures are telling us that those wrong-way traders have been favoring the long side (though most are not yet to a degree that would suggest they are explicitly negative for the market). Also, the sentiment surveys are showing a broad base of optimistic investors, as our AIM Model remains below 40%, which as I pointed out last week has had a tendency to precede below-average performance in the broader market.
There are positives too, of course. I’ve mentioned several times that the market has never simply rolled over after the type of market we saw last year. Short interest in Nasdaq stocks is extremely high, as the modified short interest ratio as posted to the site is at its highest level since 1995, except for last spring. Margin debt is not a problem, as investors have plenty of cash in their accounts to do aggressive buying, should they choose to do so.
Because of these conflicting readings, I continue to expect what I have repeated in each of the last several comments…May saw an important intermediate-term low, declines that put us into an oversold situation should be viewed as opportunities to add or initiate long exposure, we should see modest gains for the year, but the best strategy will most likely take advantage of oscillating indicators (selling overbought conditions and buying oversold ones) rather than breakout strategies. The closer we are to the top of the trading range, the less inclined I am to be holding long positions.
Short-term, our measures continue to be frustrated with the choppy market environment, and we have not seen a confluence of extremes other than a couple of fleeting intraday occurrences. As of tonight’s close, the majority of our shortest-term measures are once again neutral, and leave us waiting on the sidelines for a more definable edge.
Jason Goepfert
President and CEO
Sundial Capital Research, Inc.
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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