Trader’s Narrative

It has been an unforgiving few months in the market. It is the weekend. Time to crank up the tunes, unwind and regroup. So, in homage to the Chairman of the Board and stock market bubbles gone by:

Buy me to the moon
Let me invest among the stars
Let me remember what 1999 was like
Power steakhouses and Cohiba cigars

Fill my heart with β
Let me buy forever more
Four letter stocks are what I long for
All I worship and adore.

(Sung to the tune of “Fly me to the moon”)

“Hello, I’d like to order a rally please. Yes, the financials. Good. Can you get that here in less than 45 minutes? ok. And you take plastic right? Ahh, okay. Thanks Bye.”

The financial sector - I use the Financials Select Sector SPDR (XLF) as a proxy - has been a horrible spot in the market lately. Ever since it fell out of bed in late February this year, it has shown one of the weakest relative strengths of any sector. While the market powered ahead in April and May to reach new highs, the best the financials could do was reach their previous highs again and fall down once more.

It has been ugly. But are we anywhere close to putting this sorry mess behind us?

Looking at the bullish percent chart for the sector, I noticed that it has a relatively low 63%. That may not seem low but keep in mind that since the bull market, this sector has tended to bottom around 55%-60%. The market correction in March 2007 only took the BP% down to 65%. Maybe that’s why it didn’t rally as much.

In any case, although the bullish percent is relatively low, it still isn’t low enough to merit a rally here. Take a look at the graph and you’ll see what I mean:

Click to Enlarge Graph

The internals of the sector don’t look that appetizing either. Taking a look at the number of stocks within the sector trading above their moving averages shows: around 50% above their 200 day MA, 20% above their 50 day MA and only 10% above 10 day MA.

When we’ve seen such a short term oversold situation in the sector, it has resulted in atleast a bounce. But not until we see less stocks above their long term MA are we going to set up for a meaningful rally. Today we bounced 1.5% but I don’t think we’re in the clear yet.

The bright spot is that short interest in the S&P Financials Select Sector SPDR (XLF) is at a multi-year high. The last time it was at this level was April 2005. From a sentiment point of view this is positive and it also means that all those short sellers are providing quite a bid under the price.

To conclude, I don’t think we’re seeing any sort of capitulation here. The worst is if we just drip lower. And I’m afraid the technical picture looks like we might just do that some more. If that is the case, it doesn’t bode well for the market in general either.

Here are the top 10 components (by capitalization):

Citigroup Inc. (C)
Bank of America Corp. (BAC)
American International Group Inc. (AIG)
JPMorgan Chase & Co. (JPM)
Wells Fargo & Co. (WFC)
Wachovia Corp. (WB)
MORGAN STANLEY (MS)
Goldman Sachs Group Inc. (GS)
Merrill Lynch & Co. Inc. (MER)
American Express Co. (AXP)

Yowza! Looks like nothing can keep this maket down. Not yesterday’s profit taking, which was long overdue! And certainly not the news that terrorists are in the advanced planning stages of a hit on US interests in Germany. One way or another the market finds a way to keep going up. So let’s take an overall look at the sentiment picture out there:

AAII
After last week’s historic reading, the AAII survey this week has ameliorated and now shows a tie with both bulls and bears at 43%. The AAII sentiment survey is now neutral and the only sentiment metric out of the group which is not showing more bulls than bears.

Market Vane
Market Vane’s Bullish Consensus is calculated by going through brokerage, analyst and CTA recommendations on a daily basis. Currently it stands at 72% bullish. But since early 2004 this has had a bias towards bullishness. The lowest it has been in the past 3 years is mid-50%’s. Since this sentiment indicator can get stuck either bearish or bullish for a length of time, we have to look at it on a more relative basis.

Investor’s Intelligence
Currently the II is showing 20% bears and 53% bulls which gives a bull ratio at 0.72. This is rather high, by contrarian analysis bearish. Evenso, we’ve seen the market power ahead inspite of II readings at this level. For more information on Investor’s Intelligence.

Consensus
This sentiment survey is similar to Market Vane’s in that it is comprised of brokerages, advisory services, analysts and CTAs. And like Market Vane’s it can become mired on one side of the sentiment landscape. Right now it is at 74% bullish, which is approaching 3 year extremes. From a contrarian point of view, this is bearish for the market.

LowRisk
The LowRisk.com survey is done online each week with participants filling out where they believe the Dow Jones will finish: up 2%, down 2% or unchanged. Since this is the most jittery metric, it is useful to take a short term moving average to smooth out the data. Right now, it is sitting around the neutral zone with almost as many bulls as bears.

It is fine to look at how market participants claim they feel about the market, but we still have to look at what they are actually doing. To do that, lets take a look at Commitment of Traders and short interest data:

Commitment of Traders
This data is from the Commodity Futures Trading Commission (CFTC) and shows how small speculators, commercials and large speculators are positioned in the futures markets. Right now, the small speculator - usually the market participant to fade - is positioned short. This would be bullish from a contrarian point of view.

Public Short Interest
This data is released by the NYSE with a 2 week lag. When the public is heavily active in shorting stocks, it has usually been a very good contrarian indicator that we are bottoming. Right now though, we are seeing a derth of public short selling which has pushed this indicator to the extreme seen usually at market tops.