Posted 01/26/12 6:45 PM ET by Jason Goepfert
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1 Buyers are
showing some initial signs of exhaustion. When we see one-day reversal
patterns like Thursday, we typically get a few more days of weakness.
2 Individual
investors have been very "not bearish" for the past month, pushing the 4-week
average of the Bull Ratio to rare heights. Market performance going
forward has usually been lackluster after similar extremes.
3 Despite
extremes among many of our indicators, there are still some holdouts.
Active investment managers are not aggressively buying into the rally, and
corporate insider activity is showing no particular bias (partly due to the
quiet period during earnings season).
When the S&P has gapped open above the previous
day's high, at a six-month extreme, then reverses to close lower, the next 3
days were positive only 3 of 11 times, averaging -1.1%. All three gainers
were less than +0.8%. One-day patterns are not consistently predictive of
longer-term market peaks, however, so we'd use something like a two-day violation of a short-term trendline or
10-day moving average as a sign that the seasonal/sentiment worries are about to
play out.
Bottom Line
The market is torn between good momentum and bad seasonality and indicator values (see the "Active Studies"
and "Indicators At Extremes" sections below).
The momentum rules for now, and until price shows some signs of cracking, the
negative signs will just be a heads-up and not necessarily cause for action.
We'd be more inclined to bet on a sustained pullback should the S&P 500 close below
1315.
Three weeks ago, we looked at the
big drop in bearishness from individual investors in the AAII sentiment
survey. The single-week reading was extremely low, but that hadn't been
much of a contrary indicator in the past.
The first chart below shows every similar extreme from the
survey's inception in 1987 through 1999. It signaled right before the '87
crash, but other than that there wasn't a bear market, and the extremes didn't
lead to much other than a flattening out of the uptrend.
The second chart shows signals from 1999 through now.
Most of them again led to a flattening out of the uptrend at best, except
for the 2003 instances when we were first emerging from the previous bear
market.
Something notable about our current situation is
that the S&P 500 is not sitting at a 52-week high. That has made a
difference.
Here's how the S&P
performed over the next 2 months when the 4-week Bull Ratio reached this kind of
extreme, broken down by whether the S&P was at a high or not:
The S&P was at
a 52-week high (11 instances):
Average return: +2.1%
Average worst loss: -1.1%
Average best gain: +2.5%
The S&P was not
at a 52-week high (12 instances:
Average return: -1.6%
Average worst loss: -3.8%
Average best gain: +0.9%
There was a stark difference in performance. When the S&P hadn't yet moved
up to a new high, it showed a positive return only 4 of the 12 times, with a
nearly 4-to-1 risk-to-reward ratio during the next couple of months.
Most of our indicator groups are showing more
bearish (for the market) than bullish individual indicators. We don't have
a large number of bearish extremes, but as of January 17th we have 0% at a
bullish (for the market) extreme. That's unusual, and often precedes a
market pullback...but it would be more of a probability if we had more than 30%
of our indicators at a bearish extreme at the same time.
Most of the broad sectors are showing at least
neutral sentiment, with a few well into overbought territory, especially a
couple of previously beaten-down ones like Financials and Housing. We
typically see a pullback after those sectors reach these levels.
See
this
Data Brief for more background on the Sentiment Scores
Traders just aren't tiring of selling the Euro,
with short positions hit record highs week after week. The Pound is
nearing similarly pessimistic territory, as traders head to the US Dollar.
Despite a relentless slide to multi-year lows, sentiment towards Natural Gas has
been fairly tame. It's showing pessimism, for sure, but not the deep
levels we'd expect to see after such an extended decline.
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