Trader’s Narrative

With commodities in a bear market, having corrected sharply from just a few months ago, the white hot emerging markets which relied on them for their valuations, have stumbled badly.

Here is the Russian stock market:

Notice that a long term support line going back to 1999 has been decisively broken. The index is now trading at almost half of what it fetched in May 2008. This reminds me of the Chinese stock market - which has only gotten worse since the last time I featured it in gory detail.

Here is the long term chart of the Brasilian stock market, another heavily commodity dependent equity market:

Although BOVESPA has fared slightly better than the Russian stock market, it too has clearly broken its long term support line going back to 2002.

So what does this mean?
First, a snap back bear market rally is on cue and wouldn’t surprise most here. The nature of prices and markets does not allow for a relentless fall, nor a non-stop rise.

Second, this is yet another reminder of the cyclical nature of emerging markets. They are notorious for running from hot to cold and back again. Which can be great if you keep a disciplined approach and respect your stop losses.

Third, the consequences for the more developed markets is muted since they would only gain from an easing in inflation and reduced raw material costs. While the US markets have not been anything to write home about this year, they have held up much better than these markets. And with the cycle turning from real goods to “paper goods”, that outperformance can only continue.

In mentioning a few reasons why we were seeing an intermediate bottom, I wrote last week, after Tuesday’s 90-90 day (March 12th, 2008):

The best scenario for the bulls would be another extremely strong day which would be as or even more lopsided than yesterday’s. If we get that within a reasonable time, like a week or two, the chances of a solid bottom increases exponentially.

Today the market gave us that second nine to one up day. On the NYSE 88% of traded securities advanced vs. 10% that declined. On the Nasdaq, advancing volume was almost 92% and the index itself jumped +4.2%.

Believe it or not, it was almost exactly a year since the last time we saw bunched up extreme up days. As you’ll recall, after last year’s February stumble, which many blamed on the Chinese market, we got two “nine to one” days very close together in March 2007, just as today when the market was staring into the jaws of the bear:

Previous to that, a double 90-90 signal was triggered on June 29th, 2006. Which you may recall was also near a major low:

If you’re thinking there is something to this pattern, you’re right.

David Aronson, a professor of finance at Baruch College looked at instances in the market (from 1942 to present) when we have these double 90-90 days. His time frame for the second is much wider than what we just witnessed - 3 months. But the results are intriguing nonetheless.

After the special circumstance of a double 90-90 day, the following 60 (trading) days have historically provided a return of +22% instead of a paltry 4.5% annualized otherwise. It is more remarkable when you consider that that return comes with the assumption that you enter the market on the close, after a double 9-to-1 signal was triggered and without adding any dividends!

But there’s nothing special about the 60 day time period. The trend continues, although somewhat weaker, up to 90 trading days after.

If you’re keeping a count down, 60 trading days from today would take us to late June 2008. And 90 trading days, close to the final days of July 2008. This coincides with the calendar countdown for the AAII +50% bearish sentiment.

If you bought the S&P 500 after the March 21st, 2007 signal and held for 60 trading days, you had a ~40% (annualized) return. While if you bought after the June 30, 2006 signal and held for 60 trading days, you had a ~19% (annualized) return.

If you enjoyed this, take a look at the book: “Evidence-Based Technical Analysis” by David Aronson.

Bill Cara is a top trading/finance blogger. He’s been featured in major print media, online at Forbes.com and other very prestigious places. Bill is a fellow Canadian and has had an illustrious career in the field of finance. I respect the guy tremendously and look up to him and his success. And I also commend him on the effort that he puts into his blog. There’s just one thing that prevents me from being a fanboy: as a permabear, he makes atrocious market calls and never holds himself accountable.

Here is what Bill wrote on July 6th, 2006, just as we were forming the intermediate bottom that launched the next upleg:

If you are bullish on equities, I think you need to batten down the hatches.
Like I say, there is a storm coming. Time to reef those sails.

Tim Knight, is another highly regarded trading blogger whom I respect a lot. He’s the founder of prophet.net (a great charting tool) and an indefatigable technician. His charts are a thing of beauty. Except, as he himself readily admits, he is also a permabear. Here is what Tim wrote at the same market junction, July 8th, 2006:

I am shorting everything I can. Buying puts on everything I can. Owning nothing. My belief is the market is heading for a sustained, profound fall and my intent is to profit handsomely from its demise. There are certain sectors that seem especially juicy for a fall. Oil services. Gold and Silver. And, to keep it simple, just the good ol’ S&P 500.

Here’s what I wrote around the same time, July 6th, 2007 (Running With The Bulls):

Something similar [Pamplona’s bullrun] is afoot on Wall Street. But very few people are really paying attention and they may ‘get in the way’ of the bull.

I mention that, not to get any credit but rather because it is only fair to show you what I wrote back then myself. I did happen to get it right but only because I was standing on the shoulders of giants.

As a side note, this illustrates perfectly why I like Jason Goepfert’s site SentimenTrader so much. He is able to switch his view and stance as the data and markets dictate. Why else would I recommend him to you and give you a chance at 6 months of free access to his brilliant mind?

Getting back to the topic of accountability… To my knowledge, neither trading blog has gone back and given these calls any explicit attention. Now, I’m certainly not under the impression that bloggers should be held to the same standards as analysts or investment banks or research firms. And I’m not suggesting that we go around like a bunch of hooligans forcing bloggers to answer for their wrong calls. Their archives are there for anyone to peruse.

What I am suggesting is that we hold ourselves accountable. And do so for the simple and self-serving reason that that’s how one learns! Each time we brush a wrong call under the carpet, pretend like our call wasn’t horribly wrong, pretend that we don’t have any losing trades, etc. we deny ourselves and our readers a chance to gain further insight into the market.

So here and now, I dedicate myself to go through my own past calls. I’ll be looking forward (not to the bashing or the pats on the back but) to the insightful comments of fellow bloggers and readers so we can learn something for the next opportunity.

John, from Tale of the Tape, asks a very interesting question regarding the nature of sentiment during a bear market. He wonders whether high bearish sentiment is a bullish signal during both bear and bull markets.

Well, lets examine the bear market that began in early 2000 by looking at the S&P 500 index and the absolute readings of AAII bearish sentiment that accompanied it:

Now, be mindful that the dates for the survey and the weekly candles don’t match exactly. What I’ve done is to round ahead to the next candle/week. So for example, if the survey date is May 12th and there are two candles with start dates May 8th and May 15th, I put the “sentiment” dot on May 15th’s candle. Capisce? The result is that in some instances it may appear that sentiment was ‘off’ or ‘late’ in signalling a rally… where it wasn’t really.

Some observations from this first phase of the bear market:

• first heavy bearish sentiment was waay off for the S&P (much better for Nasdaq)
• ditto for the lighter one that came right after it
• sentiment didn’t get bearish again for a long time
• but when it did, it was a great signal for a rally in March 2001
• in early stages of a cyclical bear market, sentiment can be a great tell
• but only after the market has seen a significant decline and/or correction

And the next phase of the bear from 2002 onward:

Wow! The graph lights up like a Christmas tree:

bearish sentiment went haywire approaching 1000 - right at previous support
• naturally, a lot of people became bearish as the index revisited its lows
• bearish sentiment accompanied the index’s plunge!
• clusters of major bearish sentiment can actually be dangerous!
• it is much better to get a lone ‘dot’ than a crowd of them (see first graph)
• you need severe and sustained bearish sentiment for a significant bottom
• bearish sentiment can ‘wash out’ - no real bearish reading after March 13, 2003

But remember that sentiment, especially only one measure of it such as AAII, should never be used as a tell in isolation. Sentiment as a contrarian measure is useful, but it must be combined with other tools to round out a picture.

Today the members of AAII responded to their weekly sentiment survey with a very lopsided expectation for the next 6 months: 58% bears, 24% bulls and the rest neutral. Interestingly enough, this level of bearishness was registered after the strong close on Wednesday. So maybe people are wising up to these one day spikes, or else, they are truly very pessimistic.

The bull ratio (calculated by dividing the bulls by the sum of the bears and bulls) was last seen at these levels in early April 2005 and in mid February 2003. To find this same level of absolute bearishness (58%), you would have to go back to early 2003 :

In mid February of 2003, we saw a reading of almost 58% bears but it wasn’t until later in March that a definitive bottom was put in and a new cyclical bull born. The March 2003 bottom was put in with a 51.4% bear reading and the bull ratio was at 0.40 - higher than it is now.

The next time that AAII bearishness approached 58%, believe it or not, was way back in October 1990 :

Unlike the 2003 scenario, from August 1990 to the end of October 1990, there was an almost uninterrupted string of bearish readings above 50%. But similar to 2003, there was a dip back to retest the bottom (purple circle) in early 1991 and then the market zoomed ahead.