Trader’s Narrative

Last week we reviewed the latest position of Lowry Research on the stock market: Turbulence Ahead, Uptrend Intact. One of the major reasons that Lowry’s continues to believe in the health of the market and a continuation of the uptrend is the lack of selling pressure.

Lowry measures this through their proprietary metric called (what else?) Selling Pressure. It remains low and falling, helping to support the thesis of a healthy market rally. According to Paul Desmond: “Every major market top in Lowry’s 76-year history has been preceded by a sustained rise in selling pressure. With selling pressure recording a new 12-month low within the past two weeks, no such rise is now evident.”

This has got to be frustrating for the bears. But it is also unbelievable to the large number of participants in the market who continue to look at the current price levels as a mirage. The US retail investor is not venturing out into equities, even after watching the stock market climb a wall of worry inch by inch.

This has been and continues to be the most hated stock market rally that I’ve ever witnessed. In any case, it is comforting to confirm Lowry’s proprietary measure of selling pressure with a similar measure from InvesTech.

Click chart to see larger version:

Source: InvesTech

Jim Stack, the writer of InvesTech has a handy checklist for new bull market conditions. One of them is this metric. And along with the rest of the list, it has been flashing a bright green buy signal for a few months.

As well, the month of November has been historically one of the best months for the S&P 500 since 1950. I’m not sure that another 20% rally by year end will convince the retail investors to risk their money in the stock market again. But we may just see that.

Today’s market strength isn’t surprising as we looked at different breadth measures that suggested that in the short term, the market was approaching oversold.

But today’s strength notwithstanding, looking out further along the time horizon, we are probably going to see lower prices. According to the latest report from Lowry Research, their proprietary Buying Power Index, which measures the demand side of the market, has falling dramatically.

Concomitantly, the Selling Pressure Index - their proprietary measure of supply - is now heading up after meandering for a few months. These two taken together mean that the stock market may even retest or go through the March lows.

The usual script for a new bull market is very shallow retracements and an immediate and aggressive bounce from any oversold condition. We are not really seeing that, at least so far - which leads many to conclude that we are not in a bull market but rather continue to trundle through a brutal bear market.

Although Lowry Research is probably best known for Paul Desmond’s seminal study of the role of 90-90 days in the birth of bull markets, they themselves follow their two proprietary supply and demand indicators for guidance on future market prices. To read more about Lowry’s methodology and charts of Buying Power and Selling Pressure indexes, see this: Lowry Research On Current Market Conditions.

You can also watch Paul Desmond’s recent CNBC interview where he mentions basically the same arguments for a defensive position going forward.

The spring rally that started on March 9th 2009 took the Standard & Poor’s 500 Index 37% higher by May 8th (almost two months exactly). Since then we’ve been bobbing and weaving, first lower, then higher but really not going anywhere:

It could just be that we have no come into areas of resistance which last pushed back prices in early January. Or there could be more a more insidious reason for the recent weakness in the equity market.

In a recent Wall Street Journal article, Paul Desmond, the award winning head of Lowry Research, argues that what we are seeing is not the start of a real bull market:

“A new bull market is one when investors are prepared to commit larger and larger amounts of new money to equities… What we have seen here is a very consistent drop in total volume going back to early April. Investors are risking smaller and smaller amounts of capital and that is a bad sign.”

Mr. Desmond says his data, going back to the 1930s, don’t show any new bull market with such a weak volume trend, which leads him to believe that this rally won’t become a lasting bull market.

Among the many metrics used by Lowry Research are two proprietary ones called ‘buying power’ and ’selling pressure’. Accordingly a bull market is distinguished by a rising buying power measure and falling selling pressure. While stock prices have certainly risen, there isn’t a demonstrable strength in Lowry’s buying measure. In fact, demand has been fading.

For further details about Lowry Research and how they analyze the stock market, check out: Lowry Research On Current Market Conditions.

Yesterday’s +3% snap-back rally was one of the famed Lowry 90%-90% days. For those unfamiliar with the term, these are climactic days coined by a research report by Paul Desmond written in 2002 (you can find the original report in the free trading resource section - in the Articles and Reports section).

90-90 days are defined by two conditions:

1. Volume is extreme so that 90% or more is either devoted to downside volume or upside volume.
2. Points are so extreme that they are 90% or more either gained or lost to the downside.

These days are significant because historically, every single major shift in the nature of the market has been presaged by the presence of one or several 90-90 down days (representing panic selling) followed by 90-90 up days (panic buying).

We’ve seen quite a few of both 90-90 up and down days during this vicious bear market. So much so that they have tended to be given less and less attention. Yesterday’s extreme up day was even more significant because it was on the heels of a 52 week low. We’ve seen these before too:

But before you get excited, consider that for all its glory, the rally was an inside day. That’s hard to believe since it was so powerful. But it still didn’t engulf the previous candlestick.

As well, the volume was nothing to write home about. It was higher than the previous session’s but compared to the November low, it came up short.

Most of the impetus for the rally came from a massive short covering rally in the financial sector. The Philadelphia Bank Index (BKX) was up almost 14%.

As well, Lowry Research continues to be unimpressed by the market’s behavior. In a recent reports, Paul Desmond says:

“A lot of investors were hoping the market would hold at the November 2008 low. As those hopes were broken, investors tend to panic. We’re really at a critical stage.”

Until the market eliminates those investors who bought high but are still reluctant to sell and take a loss, it will not achieve capitulation. A sign of approaching capitulation will be a slowdown in the rate of selling. That will set the stage for investors to begin looking at opportunities. We’re still into a healthy bear market.”

For all its significance and predictive qualities, the concept of 90-90 days is just one of the many tools that Lowry Research uses to analyse the market. Their most important indicators are proprietary and measure buying power & selling pressure. According to these indicators, Lowry Research is still advising clients to stay on the sidelines because investors aren’t done selling.

Check out my previous in depth report to find out more about Lowry Research and a sample of their analysis of the market (including charts of their proprietary Buying Power and Selling Pressure indicators).

Sentiment Surveys
According to Investor’s Intelligence newsletter publishers are as gloomy as they have ever been. This week’s sentiment bearish sentiment was 54.4% with bullish newsletter editors unchanged. While slightly more than half may not seem like much, you have to understand that like most media outlets, newsletters have a positivity bias that skews readings. But keep in mind that the II measure is not completely quantitative.

The American Association of Individual Investor’s (AAII) sentiment survey in contrast continues to show that retail investors in the US have suddenly become very bold. Similar to last week’s sentiment the optimists and pessimists are both 38.74%. This apathy or lack of fear is strange and more than a little unnerving.

Volatility
Volatility continued to climb to the astonishment of everyone (first and foremost yours truly). The CBOE VIX index spiked to 89.3 and settled down to “only” 79.1 - quick someone give me a synonym for un-fraking-believable. Looking at the VIX futures market, the “smart” money, or commercial hedgers are carrying the largest long position they have ever been since the contract started. While the retail traders are taking the other side of the trade.

Options
The options market yawned as usual. I prefer the CBOE equity only put call ratio because it filters out the noise. Although it rose, it didn’t even manage to reach 1.0 - it should easily be above 1.5 considering what we are going through. I tried to explain this crazy options market. But I’m not sure if I even convinced myself. This, like the majority of what is going on, is a head scratcher.

Fund Flows
As you can imagine, mutual funds have been hemorrhaging assets as people either sell to stuff cash under the mattress or take the slightly less safe road and buy money market funds. But preliminary numbers for the most recent fund flows shows a slight inflow. Again, this is puzzling. From a contrarian point of view, the ideal condition would be a continued outflow trend, even if the market rallied or stabilized - which it hasn’t really done.

What I’m still waiting for is the tsunami of hedge funds redemptions. Usually hedge funds have a lock up period to give the manager some breathing room. The more exclusive the hedge fund, the longer the lockup but usually it is 2-3 months.

Lowry’s 90-90 vs. Selling Pressure
As the VIX indicates this is an unbelievably volatile market. We’ve had so many 90-90 days (or very close calls) that my head is spinning. On Friday 84% of volume on the NYSE was negative. On Tuesday (October 21st) we saw almost the opposite with 87% flowing to stocks trading up.

Paul Desmond’s research at Lowry’s into the efficacy of 90-90 days has permeated the trading and investing world so much that I fear it may jump the shark. But assuming that it hasn’t already, there is more to the market than just watching for these important days. Lowry’s itself calculates two aggregate indicators for the market’s health: buying and selling pressure. Right now selling pressure has the upper hand (after jumping to an extreme level). Until it subsides and buying pressure takes over, the market isn’t going to go up.