We continue to see mounting technical evidence that a major market low is near as there was more unprecedented readings from a sentiment and market internal basis last week. However, the most important piece of the market forecasting puzzle is still lacking, and that is major price gains on strong volume on a more consistent basis. Clearly, there is tremendous fear about stocks, credit markets, and the economy, and there is also strong evidence that things are washed out from an internal viewpoint, but we still need to see institutions stepping up to the plate and swinging.
From a sentiment standpoint, we believe we need to see extreme levels of fear considering the horrendous news flow, and that is just what we have been witnessing. The weekly readings from Investor’s Intelligence were pretty staggering: only 22.4% bulls and a whopping 52.9% bears. This is the lowest percentage of bulls since late 1988, and one of the lowest readings in the history of the data, which goes all the way back to the late 1960’s. It is also the highest percentage of bearish sentiment since December 1994, just before the market took off. The difference between bulls and bears is a staggering 30.5 percentage points favoring the bears, the most one-sided that newsletter writers have been since December 1988, which was also not a bad time to be putting funds back into stocks. Bulls divided by bears has fallen to 42%, also the lowest and most bearish since late 1988.
We can slice and dice the data all we want, but the clear conclusion is that newsletter writers are extremely bearish, and many times, that has been a good, but early sign, that stocks may be near the bottom.
Taking a look at other sentiment polls shows similar levels of fear and anxiety. The Consensus poll measures the attitudes and positions of an extensive mix of both brokerage house analysts and independent advisory services (they have several hundred contributors). The data covers a broad spectrum of approaches to the market, including fundamental, technical and cyclical. Just a week ago, bullish sentiment on the Consensus poll fell to 21%, matching the level last seen in May 2002. The American Association of Individual Investor’s poll showed only 31.5% bulls and a whopping 60.8% bears. This was the greatest percentage of bears since October 1990, right near the bottom of that bear market.
In our view, the lack of upside follow through on a price basis is keeping many sentiment indicators at extreme pessimistic levels. We need sentiment to begin improve, but many times this does not occur until we start seeing some strong price gains in the market. It’s like a big circle, but once it happens, the upside reversal can be quite powerful, because everyone is caught on the wrong side of fence.
One way to forecast whether fear is peaking is to look at chart formations and near-term price action of the volatility indexes. First, slopes of the indexes (VIX, VXO, VXN, and QQV) got very steep going into the bear market low on October 10. Many times, after an index or stock has been in a powerful uptrend, the last rally can be described as asymptotic. Stock prices were going straight down, forcing option premiums through the roof, and sending volatility indexes to the moon. To illustrate, the 10-day price rate-of-change (ROC) on the VIX (ending 10/10) was 101%, the highest since September 2001, and was the second highest in the history of the data. Whether prices are moving up or down, this kind of slope is simply unsustainable.
Secondly, the volatility indexes have become extremely overbought on both a daily and weekly basis. This does not automatically mean that these indexes have to start pulling back immediately, but it does suggest that we have seen a peak in momentum, and that a top may not be far behind (and a market bottom is near). Third, there have been some days recently where the indexes have closed well off their highs, tracing out candlestick formations known as an inverted hammer. These patterns have long upper shadows, and after a big move to the upside, suggest that the trend is faltering. The VXO has traced out an island reversal, gapping higher on October 10, and then closing below the gap. This is also a potential sign of a top. In our view, it would be very bullish for stocks if the volatility indexes started to correct, and would be a sign that fear is finally starting to dissipate.
From an internal standpoint, things are just plain ugly. The percentage of NYSE stocks hitting new 52-week lows soared to 88% on October 10, an all-time high. The same reading on the Nasdaq rose to 49% last Friday, and incredibly, wiped out levels seen during the great technology bear market in 2001 and 2002. The NYSE down volume/up volume ratio hit 44:1 on October 15, one of the worst readings in the last forty years. Stocks have been thrown out with indiscriminate selling, and while this is somewhat rare, we think it creates opportunities as there appears to be a real disconnect between stock prices and their fundamentals.
Oil remains in a major decline but has dropped to an area of long-term support. There is a layer of chart support between $55 and $77. In addition, a long-term trendline sits in the low $70's. This trendline has supported the market since 2001, so it is of major importance. Prices are extremely oversold, with prices 27% below the 65-week exponential average, the greatest since early 2002. The next support from a Fibonacci standpoint is a 61.6% retracement that targets the mid $60's. If the mid-60's level is taken out, we would seriously question whether crude oil is still in a secular bull market.
Shorter term, we think there is the potential for a positive momentum divergence on the daily chart, many times seen near market lows. Steepness of decline recently suggests panic selling. Sentiment has fallen to an extreme bearish level not seen since 2003. Overall, we think a bottom is near but that it could take many months of basing before things can reverse to the upside.
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