Trader’s Narrative

As promised in yesterday’s post about the NYSE bullish percent index, here are some notes from the Lowry Research meeting. You can view the accompanying charts by downloading the PDF file from the free trading resource section. The file is in the Reports & Articles folder:

In case you’re not familiar with them, Lowry is one of the most respected technical research firms. Their prestige flows not only from their longevity (they are the oldest continuously published letter on the US markets) but also due to the quality of their analysis. Their principal, Paul Desmond, won the Charles H. Dow award in 2002 for his research into 90-90 days and their role in market bottoms. They have mostly institutional clients with some retail clients paying $1000 a year for regular access to what you’re about to glimpse.

This also has some poignancy today since we have now fallen appx. 55% from the 2007 top as Paul Desmond opined: How brutal can this bear market get? We are now below the S&P 500 2002 bear market level. Is that enough? has the bear extracted its pound of flesh? Read on to find out what Desmond’s firm thinks.

The presentation was given by one of their junior analysts, Tracy Knudson (CMT). First she reviewed what happened at the market top in 2007 and then moved forward to today and Lowry Research’s view on where we are headed from here. Then a brief overview of sectors and the changing role of 90-90 days:

• Lowry is now known for Paul Desmond’s research into 90-90 days but they primarily use proprietary indexes: buying power and selling pressure
• use these two metrics to gauge health of the market and the underlying momentum to measure who has upper hand
• important to look at both components of 90-90 days: total price points gain/lost and total volume of advancers/decliners
• buying power & selling pressure calculated from public information released by NYSE for that exchange
• Lowry is working on beta versions of same for NASDAQ and international markets (still private)
• mid-July 2007 first warning sign that bull market losing strength
• new high on index not confirmed by adv/dec breadth of NYSE (OCO) operating companies only, S&P 500 or NASDAQ
• this was a sign that rally was becoming selective rather than continuing as broad-based

Continue reading ‘Lowry Research On Current Market Conditions’

This week sentiment recovered from the abyss into which it had fallen. This isn’t surprising considering the strong lift-off the market had last week. But even so, it doesn’t yet give us any reason to doubt the veracity nor the potential of the rally to continue.

Hulbert Newsletter Sentiment Index
According to Mark Hulbert, the Hulbert Stock Newsletter Sentiment Index (HSNSI) was -22.5% on Monday, March 24th, 2008.

On March 10th, 2008 when we had the lowest close in recent history, the HSNSI was a little bit lower at -25.9%. Which means that although the market has recovered from such lows, the average market timing newsletter writer is still very much bearish and recommending to their subscribers that they in fact short the market in their portfolios!

This is even more significant when we compare the reaction this rally has provoked to the previous rally in mid January. Right after the market recovered from those intra-day lows and went higher, newsletters quickly jumped on the bandwagon and the HSNSI increased right along with the rally more than 22% points.

This is exactly what I was referring to when I answered Jim’s question about trend and why I’m not bearish in the current market condition.

Sentiment Surveys
The AAII retail investor’s sentiment survey continued to recover with an increase in optimism: 42% were bullish and 34% bearish. This puts them square in neutral territory.

The II (ChartCraft’s newsletter sentiment measure) similarly recovered with a small decrease in the number of bears (41%) and a small increase in the bulls (36.7%). But unlike the AAII, the newsletter editors are still very much at extreme levels of bearishness which have historically coincided with market bottoms.

Although sentiment has shifted from the lopsided scenario we had, I don’t think this means that the rally it birthed is in danger. For the market to go up we need people to start buying again and for that, they need to not be so afraid. That, however, is different than a quick shift from one extreme side of sentiment to the other.

ISE Sentiment
This week we’ve seen a consolidation after last week’s rapid recovery. The ISE Sentiment Index, however, is showing that this has lead the retail option traders to quickly lose any excitement for the rally:

ROBO Put Call Ratio
This proprietary measure created by Jason Goepfert of SentimenTrader.com keeps track of what the small retail option traders are doing.

The most recent data is showing that the retail investor is very worried. The ROBO put call ratio is 0.91 - that’s from 0.68 in mid February 2008.

To find similarly pessimistic times when the retail investor was buying puts so frantically, we’d have to go back to early 2003, just as the bear market was coming to a close.

Because of the delay in getting OCC data, this reflects what was happening in the option market last week. But it is nonetheless useful on an intermediate to long term time horizon.

I’ve been yammering on about market bottoms, bullish indicators and contrarian sentiment and other similar ideas for some time. The only thing I haven’t done is reach through the monitor and slap you around till you get some long exposure

Today money flowed into advancing stocks to a staggering degree. As measured by volume, advancing issues were 3.5 times the declining ones on the NYSE and 8.3 times on the Nasdaq. That’s short of the sort of stampede that gives us the rare and valuable 90-90 days but there was no question buyers were in control.

Yesterday’s market action was similar although much more muted. Coupled with Monday’s hammer candlestick, we now have 3 consecutive up days. It would seem (if I may count my chickens before they hatch) that we are having a successful retest of the mid January lows above the 1320 S&P 500 level.

You’d think that in a such a scenario people would be bullish, or atleast a bit excited, right?

Turns out that while the market has been going higher, people are actually not excited at all. In fact, they’re slightly more bearish! Check out this chart comparing the S&P 500 index (candlestick) with the CBOE equity only put call ratio (line):

Take yesterday as an example. While the S&P 500 reached 1360 and managed to close up 0.93%, the CBOE equity only put call ratio went from 0.68 to 0.78 - meaning that people bought more puts than the previous day. Also, the ISEE Index dropped from 115 to 82 - meaning that people bought less calls than the previous day.

Today the market went up another ~1% and we had the CBOE put call ratio drop ever so slightly (almost unchanged) and the ISEE Index dropped again, from 82 to 72. That’s equally as pessimistic as February 5th, when the market fell 3.2% in one day!

Of course, the usual and expected pattern is for option traders to buy calls when the market goes up and to escape into the shelter of puts when it goes down. The opposite happens from time to time and I don’t want to read too much into just two day’s worth of data but nevertheless, it is noteworthy.

It would be very normal for the market to pause and digest this short term move up but the negative sentiment is undeniable. And it is congruent with other things I’m seeing. For example, most of the email I get is about how we are about to fall again and how the “bulls are going to get slaughtered”, etc.

The market can be a sadistic vixen, exerting maximum pain on the maximum number of people. That’s when it pays to be in the minority.

The bond market and the stock market are intimately intertwined. But how exactly they influence each other is often complex. The dynamic nature of their relationship makes it even more difficult to read the market’s tea leaves. As soon as you think you’ve figured them out, the interplay among them changes and the game starts all over again.

I’ve already described one way that I link the two together: the monthly rate of change for bonds. This is a useful indicator that has not only provided guide posts for market bottoms but also times when the market has climbed into thin air territory and is about to be humbled.

Here’s another, similar method:

As the chart above shows, this is the annual rate of change for the 10 year US Treasury Bonds. Since it is based a longer time frame, it reaches extreme levels much less frequently than the monthly rate of change.

Right now, the annual rate of change for 10 year bonds is very close to reaching the historic level that has marked a top for bonds (and a bottom for yields).

Interestingly enough, each of those times was also a good time to not only sell (or sell short bonds) but also to be long stocks:

Every trader prays for volatility because without it, prices wouldn’t move and there would be no chance to make a profit. But too much volatility can be as deadly as a quiet market. It would be a crass understatement to say that we are experiencing tremendous volatility these past few weeks.

The stock market has been either going up or down by at least 1%, for more than 70% of the trading sessions these past three weeks. This amount of volatility is both extreme and rare.

While stop losses are getting hit all over the place, the good news is that this level of volatility has a good track record of signaling important market bottoms.

A good measure of price volatility is the technical indicator known as “Average True Range” - developed by Welles Wilder in his 1978 classic: New Concepts in Technical Trading Systems.

As you can see in the chart for the S&P 500, the average true range is as high as it has been since 2002 (yet another indicator hitting these chronological extremes).

In case the graph is too small to see, the 2000 signal was for the mid April 2000 “mini-crash”. On a chart like this one, the fall and snapback rally may seem insignificant, but if you were there during those days, you would remember the harrowing experience.

And since I haven’t been featuring the venerable Dow Jones enough, here’s a chart for it showing similar signals: