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Reasons Why This Is An Intermediate Bottom at Trader’s Narrative





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Double Bottom Thesis
One of the technical patterns everyone has been watching for during the recent market action is one of the most common and well known ones: double bottoms.

SP500 double bottom 2008 thesis

Thanks to yesterday’s rocket ride, it looks like this pattern now has a chance. What we need to look for next is that the low isn’t violated (obviously!) and two, that we can successfully take out the resistance levels just underneath 1400 on the S&P 500 index.

Lowry’s 90-90 Day
Everybody is emailing me asking if Tuesday was one of those famous Lowry’s 90-90 up days. I don’t have confirmation from the keeper of this measure but I’m 90% (no pun intended) sure that it was indeed a 90-90 day. It certainly looks like the market is getting ready for a running of the bulls.

In case you’re unfamiliar with the nomenclature, a 90-90 day is when we have such a lopsided day in the markets that 90% of the volume and 90% of the points are on the same side (either up or down). Research by Lowry’s has shown that historically, important market inflection points are preceded by extreme crowding to one side, then the other. If you’d like to read the original version (and save $10) download the research paper from my free trading resource section.

The best scenario for the bulls would be another extremely strong day which would be as or even more lopsided than yesterday’s. If we get that within a reasonable time, like a week or two, the chances of a solid bottom increases exponentially.

Sentiment
Yes, I know I’ve been harping on this for a while now but until recently we hadn’t really seen any truly extreme readings in the usual sentiment measures. Sure, they were gloomy but now we’re finally seeing some bearishness of epic proportions. This is a vital element, as the market approached the January 2008 lows, to determine if we are going to simply cascade lower or carve out a double bottom.

I’ll write up a full report covering the various sentiment measures in detail for the weekly sentiment overview on Friday.

Put Call Ratio
We had a historic reading in the commonly followed CBOE equity only put call ratio - the highest in years. As I mentioned then, for some strange reason, it seems that an inflection point doesn’t coincide with such panics in the option markets but instead follows a few days after. Well, it is a few days later.

Percentage Above Long Term Averages
This market is oversold. Is that too simple? Here’s a weekly chart of the small caps, Russell 2000 Index (RUT) showing the percentage above their 150 day moving average:

russell 2000 percent above 150 moving average

And here’s a daily chart of the large caps, Dow Jones Industrial Average (INDU), showing the percentage of stocks above their 200 day moving average:

percent dow stock above 200 MA long term

The last time we had 10% of Dow Jones components trading below their long term moving average was when we were just finishing up the bear market of 2002-2003.

“Dumb Money Confidence”
One of the most important proprietary indicators that I watch from SentimenTrader.com is the “Dumb Money Confidence” index. It is an aggregate of many indicators and along with the “Smart Money Confidence” it shows where we are along the market cycle.

The most recent reading is 13 (the indicator runs from 0 to 100) which is extremely low. This is a result of the abysmal sentiment out there but it also reflects how extremely oversold we are now. The previous times we’ve had such a low reading has been in August 1998, October 1998, September 2001, July 2001 and February 2003.

Financial Sector
Since a huge portion of this market decline is related to financial stocks (through the mortgage credit crisis), it is vital that they be the ones to lead any rallies. We’ve seen this sector jump around on the rumor du jour but what we really needed was something substantial.

Which we got on early Tuesday. While the general market rallied 3%, financial stocks were up 7%. This was an obvious reaction to the Federal Reserve’s new $200 billion intervention. The number is puny compared to the nominal amounts at stake in the financial markets. But what is important is that for the first time during this crisis, the Fed is using a scalpel rather than a sledgehammer.

Stock and Bond Dislocation
I’ve already mentioned that these two important markets were becoming more and more dislocated: stocks were cheap and bonds expensive When the two markets become disjointed it usually flags an important inflection point.

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17 Responses to “Reasons Why This Is An Intermediate Bottom”  

  1. 1 Richard

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    All you say looks right, but what worries me is the ferocity with which any rally gets killed off immediately. Last Tuesday’s rally did not even survive the next day and now we are back to test the lows.

  2. 2 Keith Shepard

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    Good post. Well thought out and nicely supported with data. I think the oversold technicals might turn up before the market does merely from a sentiment POV.


    Keith

  3. 3 Jagmohan Swain

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    We are still early.Need to take out the lows of Jan before we rally in s&p.

  4. 4 just doug

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    I agree with the indicator analysis - at least in isolation. What bothers me about the intermediate to longer term bullish case is that we are implicitly assuming the underlying economic conditions are comparable between the periods in question. I think there is good reason to believe they aren’t. We may be using the same indicator levels to judge the recovery from a sprained ankle as from a shotgun blast to the gut.

  5. 5 MrEd

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    Don Hays is a doofus. I’m sorry but this guy is completely wrong on his thesis. As are his crude models. The IBES valuation model he screams about is a complete joke. I’ve seen the work around this type of model and coded it myself. It’s utterly useless except as VERY anecdotal supporting data.

    The premise is that buyers support the market in the PM and closing highs are supportive of future gains. Uh……That assumes stock traders are correct. As we are finding out now that almost all of Wall Street was bullish beyond belief going into 07 and every major brokerage is still expecting a positive return in 08 as of January……….

    This indicator has no quantitative value IMO. Your other comments on the blog are worthwhile but this is not.

  6. 6 John Tyler

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    How’s your double bottom doing?

  7. 7 wes

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    MrEd,

    I agree that the IBES model has been largely useless so far this century. It’s my belief that the problem is that this model doesn’t take profit margins into account.

    By the end of 2007, profit margins were near historic highs, nearly 40% above their average.

    It is only sensible to guess they won’t stay at these high levels.

  8. 8 Jagmohan Swain

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    IBES valuation model is fine in a secular bull market when stocks are recovering from low valuations.That phase is gone now.Fed is trying hard to reverse the business cycle and that only makes matters messier not better.Why can’t Fed just keep it’s hands off and let the natual ebb and flow of economic forces take over.Nevertheless I happen to be bullish here and looking for a capitulation event before going long.I think the rest of the year is going to be quite positive.Booyah!!

  9. 9 Dr. Duru

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    Could you clarify why you are tagging the currnet action as an intermediate bottom as opposed to a short-term or long-term bottom? You didn’t even use the term “intermediate” in the post besides in the title…

  10. 10 Tim

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    There is no new leadership emerging and the up day was only 1 day. Until new leadership emerges, rallies will most likely be weak.

  11. 11 Babak

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    Dr. Duru,
    I used the label intermediate because of the indicators I’m watching. Long term would indicate a secular bull market. Although there are some indicators for such things, these aren’t it - they are too short term for that. And I didn’t call it short term because there are so many indicators and so many of them showing such extremes that it can’t just be foreshadowing a “blip” up.

  12. 12 Scoad

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    There’s your 90/90 day Babak now maybe you won’t need that installment loan- best yet its an FTD for last Tues, for which it seems there’s a little dissention as to whether that was a 90/90 day but whatever, it was a goodun by any standard.
    So now the 6 trillion $ question- does it work or are there too many wiseguys doing tradestation in their pajamas for even this to work?

  1. 1 Evidence-Based Technical Analysis by David Aronson
  2. 2 Question From Reader: Why Not Follow The Trend ?
  3. 3 (Yet) Another Lowry’s 90-90 Up Day
  4. 4 Sentiment Overview: Week Of May 16th, 2008
  5. 5 Sentiment Overview: Week Of May 30th, 2008


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