Trader’s Narrative

I don’t know how some get the impression that I’m a perma-bull. I’m human, so by nature I’m biased. However, what I try to do always is to allow the tools and indicators to speak for themselves.

For example, on Wednesday (February 27th, 2008) I wrote a cautionary note that based on overbought breadth of both the Dow Jones Industrial and the S&P 500, the mini-rally wouldn’t keep up the pace.

My hunch was that we’d schlep around until it worked off and then head higher. But in any case, overbought is overbought. When you have both the indices showing 80% of their components trading above their 10 day moving average, you have to rein in the longs and bunker down.

Dive, Dive, Dive!
But instead of meandering, the market worked off its overbought breadth by nosediving. For those keeping count, the last time the S&P 500 was down hereabouts was in early February but the breadth numbers were washed out. We had only 20% of stocks in the S&P 500 trading above their 50 day moving average. Now we have 31%. We had a measly 17.5% above their 200 moving average. Now we have 21%.

My point is that the market has rolled over (again) without first getting really overbought in anything over than the shortest time frame possible - the aforementioned 10 day moving average. I don’t like that.

CBOE Put Call Ratio
Something else which bugs me is that on Thursday when the market fell a fraction of today’s move, the CBOE equity only put call ratio spiked to 1.0 (or for the obsessive compulsives: 0.966).

But today, when red filled trading stations the CBOE ended up falling! It closed at 0.836 if you can believe it. So according to this gauge, the option traders aren’t afraid - even in the face of a 2.5%+ decline

This is odd, and disconcerting. Yet, it is part and parcel of the mystery that is the market. These counter intuitive days when the put call ratio walks with the index are rare but they do occur. Sometimes they paint a bullish picture and other times not.

ISE Options Data
The ISEE index shows a more congruent picture with a dramatic decline in the number of calls relative to puts. Friday saw the ISEE index fall to 75 from 97.

That’s about as low as it got in mid February 2008 when the S&P 500 was trading slightly above Friday’s close. In contrast to the CBOE put call ratio, the ISE Index is saying that option sentiment is anything but apathetic.

Market Internals
How did we go from expecting a 90-90 up day to put a nice bow on the rally to getting a 90-90 down day? That’s what I’d like to know.

Maybe it was the short term overbought that I mentioned on Wednesday or maybe something else. In any case, we’ve been jarred from the slow and steady recovery from the January spike low with horrible market breadth.

Depending on which market data provider you use, we got anywhere between 2340 to 2400 declining issues on the Nasdaq and 2700+ on the NYSE. This has only been exceeded during this year on January 17th, when the market made its swing low.

Taking a quick glance at the graph of declining issues, I noticed that usually a low was carved out two to three trading sessions after such a spike high. Curious that it didn’t match such a wash out decline in breadth:

Hurts So Good
To leave on a positive note, the same short term indicator that that flashed a caution on Wednesday is now saying the opposite.

Of the 500 components of the Standards & Poor’s Index, only 13% are now above their 10 day moving average. This is low “enough” but if it happens to fall to less than 10%, without causing a concomitant fall in the indices, then the bulls are in for real a treat.

That’s because whenever we’ve had a similar deep oversold condition, even on such a short term time horizon, the market has rebounded strongly - see Lowry’s research.