Trader’s Narrative

By Nico Isaac

In recent months, Elliott Wave International President Bob Prechter has become something of a household name. In the final two days of August 2009 alone, Bob was mentioned by several news outlets from MarketWatch to the New York Times. The claim to his “fame” –

EWI was one of the only technical analysis firms to anticipate a sharp rally in U.S. stocks as they circled the drain of a 12-year low this spring, a feat made ever more exceptional considering the widespread image of Bob as being the ultimate “Big, Bad Bear.”

The lesson? Believe in the facts, not in the “widespread image.”

Bob Prechter has always said that successful forecasting should look to the current wave count (and various other technical measures) for direction. He has never permanently tied himself to the mast of definition — i.e. “bull” or “bear.”

For this reason, EWI’s team of analysts have been able to stay one step ahead of the biggest turning points in the Dow Jones Industrial Average, from the very start of the index’s historic 2007 reversal.

To wit: This two-year chart of the Dow incorporates several calls from our past publications as they coincided with the market’s most memorable peaks and troughs:

For more analysis from Robert Prechter, download a free 10-page July issue of Prechter’s Elliott Wave Theorist.

The chart above presents the abstract details of our past analysis. Here is the expanded version of those insights as they appeared in real-time:

July 17, 2007 The Elliott Wave Theorist:

“Aggressive speculators should return to a fully leveraged short position now. We may be early by a couple of weeks, but the market has traced out the minimum expected rise, and that’s enough to act on.”

Soon after, as the DJIA neared its own historic Oct. 11, 2007 apex, the Oct. 9 and 10 Short Term Update amped up the urgency of its analysis and wrote:

“Odds have increased that a market high is in place. The structure, coupled with turns in the other markets, suggests a top is in place. The potential, at the least, is four a large selloff… Watch Out! The market faces a stout correction.”

Before landing at its March 10, 2008 bottom, the March 5 Short Term Update afforded respect to a bullish alternate count and wrote: “Prices should carry above the wave a high before it ends.”

At its four-month high, the March 16 2008 Elliott Wave Theorist went on high, bearish alert and wrote: The DJIA is entering “Free Fall territory.”

One week before the U.S. stock market landed at its 12-year low of March 9, our Feb. 27, 2009 Short Term Update utilized a traditional turning pattern to outline a specific time window for the onset of a major upside reversal. In STU’s own words:

“By all indication, this pattern is back on track… the turn will come on or near March 10, 2009. Anywhere in this time period may mark a turn, which will obviously be a market low.”

Once the bullish winds of change had turned, the March 16 Short Term Update wrote:

“When the market speaks, it behooves us to listen. The implications of this are that the… major stock indexes are in the initial stages of a multi-month advance.”

Finally, the April 2009 Elliott Wave Financial Forecast calculated a specific target range for the Dow’s rally: the 9,000-10,000 level.

So, now that the upside objective is met, where are prices set to go next? For more analysis from Robert Prechter, download a free 10-page July issue of Prechter’s Elliott Wave Theorist.

Robert Prechter, Chartered Market Technician, is the world’s foremost expert on and proponent of the deflationary scenario. Prechter is the founder and CEO of Elliott Wave International, author of Wall Street best-sellers Conquer the Crash and Elliott Wave Principle and editor of The Elliott Wave Theorist monthly market letter since 1979.

Earlier in this month’s sentiment overview, I mentioned a lesser known sentiment indicator called the “Daily Sentiment Index” (DSI). It is compiled and disseminated by Jake Bernstein’s firm through various “proprietary data collection methods” which include internet, telephone and/or email.

Since the objective is to arrive at a contrarian signal, pains are taken to only access retail traders and investors and to avoid professional traders. Also according to Bernstein, they do their best to survey the same base as much as possible. The resulting data is available daily on major global indices and commodities without lag by 4pm the same day. Overall, it has proven itself to be a very good contrarian measure.

Here is a recent chart of the US Dollar index along with its DSI:

Similar to other, more well known sentiment indicators (such as the AAII weekly sentiment survey), a simple question is asked: are you bullish, bearish or have no opinion. But unlike the AAII survey, the DSI is a considered ‘a proprietary indicator’ and there is no detailed disclosure of its exact nature or methodology. While you might think this opacity would make people reluctant to rely on it, the DSI has a large and loyal following, especially among the institutional crowd who don’t balk at paying almost $2,000 a year for a subscription. You can get more information on the DSI at Bernstein’s website.

For some perspective, here’s a very long term chart of the US Dollar Index with the two extreme lows in sentiment:
Continue reading ‘US Dollar Sentiment: Contrarian Bullish’

It is Friday, time for this week’s sentiment summary:

Sentiment Surveys
The Association of American Individual Investors’ weekly sentiment survey had the bulls at 28% again (a decline of 10% points) and the bears increased by the same amount to 55%. This definitely moves sentiment towards real pessimism. The bull/bear ratio is almost equal to late February. But we aren’t quite at an extreme point - yet.

In contrast, there is not much excitement in the weekly Investors Intelligence survey as it is almost unchanged from last week. The optimists number 42.7% and the pessimists 30%.

ABC News/Washington Post Consumer Comfort Poll
Although the Reuters/University of Michigan Consumer Sentiment survey is the most popular measure of the economic mood of the average American, there are a few others. One of these is the ABC Newss/Washington Post Consumer Comfort Poll which has been conducted for almost 24 years, every week.

In contrast to the recent Reuters/Michigan Consumer data, this poll shows that US consumers are losing confidence. The past 3 weeks have it hovering at -50. In its entire history, it has only spent 14 weeks below -50 (with 8 out of those 14 occurring this year!). If this pace continues, it will be the worst year for this indicator yet.

Continue reading ‘Sentiment Overview: Week Of July 10th, 2009′

Here is this week’s sentiment summary:

Sentiment Surveys
Figures from ChartCraft’s Investors Intelligence show stock newsletter editors to be similarly bullish to last week: 43.6% bullish and 28.7% bearish. Not only is this little changed from last week, it leaves us mired in a neutral morass which is not really helpful in determining a trend.

In contrast, the weekly AAII data is a bit more attention grabbing. As measured by the American Association of Individual Investors, the percentage of US retail investors who are bearish increased by 3% points to 49% and those who are bullish declined by 5% points to just 28%.

As you might recall, we saw a record setting AAII bearishness that coincided with the start of the spring rally. This week’s sentiment figures are the most pessimistic since then. While some would interpret this as bullish for the market, it may not be that simple.

While sentiment is helpful in pointing out inflection points at extremes, the rest of the time as it meanders it is either not really helpful at all. If you really want to analyze it, sentiment tends to go along with the trend in the market until it tips into a severely lopsided situation. So in fact, while we are not seeing extremes, sentiment can be seen as a guide to confirm a trend, rather than as a contrarian indicator. This is a distinction that makes sentiment much harder to analyze than merely zigging when it zags.

Therefore, since the AAII data isn’t at an extreme level of bearishness, we can’t really use it as a contrarian measure. All we can say is that fewer people are bullish, which means that less and less are feeling like putting money to work. That isn’t necessarily great news if you’re bullish.

Finally, the Hulbert Stock Newsletter Sentiment Index which is another measure of stock newsletter editor’s stance has fallen from 45.8% early in June 2009 to just 15.8% in recent days. Such a retreat confirms what we are seeing in the other sentiment data (above); bullishness is fading to varying degrees but it is not yet at a point of extreme. Mark Hulbert, the creator and keeper of this sentiment indicator, believes that such a move has contrarian portent because while sentiment has fallen to levels last seen in early April, the market is much higher.

Options Sentiment
The CBOE put call ratio’s short term moving average is climbing higher after reaching a low in mid May 2009:

Keep in mind that the put call ratio has a slight upward bias so if you draw a line you can see the connection between the July and October 2007 put call ratio lows - which coincide with the bear market top. While this measure of sentiment has increased in recent weeks, it is a long ways off reaching previous highs of 0.85+.

Below is an updated chart of the ISEE Sentiment Index (equity only) which I showed about a month ago:

Similar to the CBOE put call ratio, we’ve seen a decrease in bullishness (notice that the ISE is inverted because it is a call put ratio). Since early June 2009, the 10 day moving average has come almost straight down from 181 to 152. But as you can see, it is far from an extreme low. On November 24th, 2008 the 10 day moving average of the equity only ISE call put ratio was 108 and on March 24th, 2008 it was 104.

I’d caution you to take all options analysis with a salt lick. Both the CBOE and ISE data has not conformed to historical ‘norms’ of sentiment analysis during this bear market. For example, notice that neither recognized the March 2009 lows.

Volatility
The CBOE volatility index (VIX) continued its slow, meandering crawl downwards this week. It closed a hair’s breadth below 26, which is the lowest it has been since September 15th 2008. The VIX has fallen off many radars because during this bear market it reached unheard of levels and as a result, what was once considered extreme is now the new ‘normal’. I suspect that it will be a long time until we can put this whole episode behind us and take a look at the VIX the way we used to before.

Here’s the sentiment summary for this week’s trading:

Sentiment Surveys
According to the sentiment surveys, an alarming number of investors and market timers have returned to the long side. The weekly AAII retail investor sentiment survey shows 48% bulls (an increase of 8% points) and 37% bears (a decrease of 12% points). We haven’t seen this many bulls in the AAII survey since the first week of the year. As I’m sure you’ll recall, that was not a happy time for putting new money to work on the long side.

According to ChartCraft, the weekly Investors Intelligence newsletter sentiment survey shows 42.5% bulls and 25.3% bears. The S&P 500 ended the week 21 points higher (or 2.2%) so the market hasn’t really done anything to deserve such hope or devotion.

Barclays Capital Sentiment Survey
Barclays Capital said that only 17.5% of the 605 respondents to its quarterly sentiment survey believe that ‘risky assets’ have more room to rise. Those taking part in the survey were central banks, asset managers and hedge funds. The majority believe that the world economy will experience either a protracted slowdown or if it is in recovery now, it will falter once more (a “W” shaped recovery). Asked whether the spring rally was just a “bear market rally”, 60% agreed - indicating that there is still a lot of dry powder out there.

NAAIM
Along with most sentiment measures the NAAIM trend survey of managers has recovered since the spring lows. For more information on the metric check out: NAAIM Sentiment Survey.

Market Froth
We’ve seen a lightning fast return of speculative trading to the stock market. You can see it in the volume of ‘garbage’ stocks (trading below $5/share) and in the general willingness of most people to shrug off the dark foreboding sense they harbored just a few months ago that the end was nigh.

There is also mounting evidence from the Rydex fund flows that the trigger happy traders that use these securities to time the market are piling into the long side. This is the case for both leveraged and normal Rydex funds and has in the past marked either significant market tops or the start of a plateau. In either case, when there is so much lopsided optimism in Rydex mutual funds, it is a flashing red light for those long the market.

Magazine Cover
I have a gut feeling that this week’s Economist magazine cover should be framed somewhere for posterity. It is a graphic showing a Tyrannosaurus Rex made up of car parts, leaking oil (as if bleeding).

I can’t help but wonder, if by the time a magazine puts up something like this, have the auto industry sector reached a nadir?

And I’m not thinking that because the image is hyperbole but because it is a creative representation of the unvarnished truth. I’d prefer if it was on Newsweek or Time but we’ll see. I think this Economist cover is one we’ll come back to years from now.