Trader’s Narrative

Another horrible day on Wall Street with pretty much the whole screen in red. Fear and loathing is getting thick. The only redeeming characteristic of the market is that we are seeing technical signals of extreme oversold all over the place:

Option Traders
ISEE Sentiment Index reached 60 - meaning for every 100 puts, 60 calls were purchased by retail traders. The last time it was in this range was in March 2007 and August 2007.

The CBOE (equity only) put call ratio almost reached the magical 1.0 level again - the second time this week. Both of these indicators are showing a lot of fear in the options market, especially from retail traders. Which is great from a contrarian perspective.

Volatility
Until today, the VIX index had been surprisingly muted. Not any more. It spiked 17% to almost 29. And more importantly, relative to its moving average it is now within reach of an extreme high that has marked previous market troughs. But as Bill (the expert on the VIX) explains, we can certainly bottom without any sort of spike in volatility.

Market Internals
On the big board, there were 2,694 declining stocks and only 475 advancing ones. Likewise, declining volume surged to 1,957,006,000 while advancing volume was only 206,905,000. Things were similarly bleak on the Nasdaq.

My guess is we just had another another 90-90 (Lowry’s) down day. The previous one was January 11th 2008. Back to back 90-90 down days are normal. What we need next is a decisive 90-90 up day now.

Market Breadth
Wherever I look, there are indicators of a very oversold market. The bullish percent charts of the Nasdaq, NYSE and the S&P 500 are showing either 52 week lows or multi-year lows:

Likewise, the charts of indices for the percentage of stocks above moving averages are at extreme lows. For example: less than 11% of S&P 500 stocks are above their 50 day moving average. And less than 20% above their 200 day moving average.

Same thing for the new high-new low index for various markets. It can always get even more critical but right now, that looks unlikely since most breadth indicators are hugging the redline extremes.

Capitulation
Finally, we’ve had a famous bull throw in the towel. Dan Sullivan, a newsletter writer and a veteran of the markets has liquidated his holdings and gone 100% cash. Usually a significant market bottom doesn’t arrive until it shakes out all but the most resolute bulls.

Considering everything, I just can’t see how this is the beginning of a bear market. Usually they are accompanied by euphoria, good news and smooth sailing but now we are seeing crisis after crisis, panic, fear and loathing. Just the sort of thing that builds a wall of worry… which a bull market climbs.

Here’s this week’s sentiment commentary:

Sentiment Surveys
LowRisk is showing the most positive picture with bulls falling to 29.4%. In contrast, AAII bulls are at 49% and the II bulls at 55.6%. I don’t know about you but I’ll take the latter surveys over the one exception.

It isn’t surprising to see the AAII bulls jump so high, so fast. After all, even in the darkest days of August, their pessimism was guarded. They never really got spooked. Now that the market has recovered, they’ve jumped on again. From a contrarian perspective, that doesn’t bode well for the market going forward.

Narrow Range & Low Volatility
Since I suggested to sell something, the market has entered a narrow range, meandering with no conviction. The rhythm of the markets is such that expansion tends to be followed by contraction. Just as you need to breath out, before you can breath in again.

Volatility (VIX) which spiked to 37.50 just a month ago has collapsed to less than half. That doesn’t automatically mean that the market can’t continue to climb. Remember, low volatility has no correlation to market behaviour (as opposed to volatility spikes). What it does tell us is that the low risk opportunity to buy was back then when the VIX spiked, not here — click to see a long term chart of the relative VIX index.

Magazine Cover Indicator
Here is this week’s Economist magazine. The gun has an inscription “Made in America” - implying that the credit crisis began in the US and as the trigger is being pulled, it will “trigger” a new downturn. At least, that is the question the cover is asking rhetorically.

There is no question that this cover is negative but the metaphor of a gun being pulled is a bit awkward so I’m not sure if it qualifies as one of the classic magazine cover indicators.

In any case, as a contrarian indicator, I would interpret this mildly bullish for the market and for the whole credit mess. I think the worst is behind us. The market still needs to mop up the mess and that will take time, but it doesn’t make sense to wallow in fear and loathing about something when it is on the cover of magazines and when journalists are writing related articles at the fastest clip ever.