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The Battle Royale Between Fundamentals & Technicals at Trader’s Narrative





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During the past few weeks, the bulls and bears have been in a battle royale at the precipice of the February 2010 support level. The S&P 500 index has finally broken above the range with a positive close at today’s high. It also regained the 200 day moving average.

The two camps are mostly divided along ideological lines. If you’re bearish on the stock market, I’d wager that you give more weight to fundamental considerations like:

And if you’re bullish, you probably give more weight to technical analysis, like:

Meet the Bears
Nouriel Roubini (RGE), Bob Janjuah (RBS), Dylan Grice and Albert Edwards (Societe Generale), David Rosenberg (Gluskin Sheff), etc. The names are familiar to you already and so are their opinions. These are the bears and for the most part, they build their convictions on fundamental analysis.

The two camps are divided and pitted against each other with a few exceptions. Richard Russell who is widely recognized as the most exceptional student of Dow Theory is now bearish citing technical breakdowns and the fear of deflation. Robert Prechter, the recognized authority in Elliott Wave analysis is also bearish, expecting the continuation of the secular bear market to take prices back to March 2009 levels. And finally, Mark Steele (BMO Quant/Technical Research) who told clients to “Go to Cash - In Plain English“.

Among the reasons for issuing a “Get out!” message, Russell pointed to the break down in leadership stocks like Google (GOOG). But if I may be so bold as to quibble with the oracle of the Dow a bit, I would like to point out that the while Google has been showing weak relative strength for some time, other leadership stocks - including Apple (AAPL) which he specifically pointed out - are doing just fine. In fact, the advance decline breadth (see above link) demonstrates that the majority of stocks are in fact much stronger than the superficial numbers on the indexes.

I do not have a monopoly on truth nor do I pretend to know what will happen. I’m simply pointing out that for the most part, the bulls and the bears are split along how they approach the market. And I don’t disagree that if you look at the fundamentals, things look absolutely horrendous right now.

Sentiment
But isn’t that reflected in the sentiment and posture of investors and traders? We’ve already looked at sentiment during this decline so I won’t go over that again. You can find the weekly overviews here: Week of May 28th, June 4th and July 11th.

As well, while Market Semiotics continues to be bearish long term (who isn’t?) but in the short term a bounce would not be a surprise since their proprietary sentiment indicator (Semiotics Sentiment) has collapsed to just 1% after bumping its head on the ceiling at 100% in late April.

Smart vs. Small Option Traders
In contrast to the “smart” option players who trade in S&P 100 index options and are leaning into this decline, the smallest option traders are buying protective puts at a very high rate. Referring to the ROBO option sentiment indicator, Jason Goepfert of SentimenTrader.com wrote recently:

Last week, small traders spent 24% of all of their option volume buying protective puts - at the worst of the worst times during the prior bear markets, that amount only reached 28%, so we’re not too far off from that.

After only a ~14% decline, small option traders are spooked enough to load up on puts to almost the same degree that they did during the darkest days of a harrowing bear market. If that doesn’t tell you all you need to know, consider that last week the S&P 500 index closed up by about 2.5%. So this shift in retail option sentiment becomes even more contrarian. That tells me that we have washed out a lot of weak hands, making the case for higher stock prices in the short to intermediate term.

Click to see larger chart in a new tab:
S&P500 index Lowry Research annotation Jun 2010

Lowry Research Update
Pimm Fox sat down with Richard Dickson again last Thursday and for the most part, the Senior Market Strategist at Lowry Research reiterated his view that this is a correction, not a new bull market.

Dickson also mentioned that we would need to see confirmation of the 90%-90% upside day on June 10th. We got that the following day, last Friday and we also got it again with today’s close. This took us above the range and the long term moving average. Another important point that Dickson touches on is the light volume accompanying the rally from the lows. In his views this is not necessarily a negative as it means that supply has been exhausted.

To listen to the interview, press play and let it buffer, then jump ahead to the 25 minute mark to listen to the complete interview:

Survey Says…
A few of you may have noticed an unobtrusive pop-up in the corner of your screen asking if you would like to take a reader survey. In case you haven’t, it is because it is shown to very small sample of the total visitors so as to not be annoying. If you do see the survey invitation, I would appreciate it very much if you would fill it out so that I can get to know my readers a bit better.

The responses are anonymous and your privacy is respected. There are about a dozen basic questions which will take you less than 2 minutes to complete as well as a spot for you to give me general feedback or to request specific topics you’d like to see more of in the blog.

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14 Responses to “The Battle Royale Between Fundamentals & Technicals”  

  1. 1 Tyrone Garibaldi

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    A lot of my friends have sold their mutual fund holdings. My sister asked me about bearish ETF. So many people were spooked by the flash crash. It is time to go long again!

  2. 2 Justin

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    Have you ever seen this, “lack of supply” happen in the past? If we don’t get a good follow through on real nice volumn then I would be inclined to get bearish again. Another question: How much have the quants, (and perhaps the PPT), do you think contributed to the extreme readings of the TRIN, Vix, etc? I have never seen a market act this much out of character before.

  3. 3 Kristjan

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    Babak,
    I’d be happy to fill out the survey but when I tried clicking on it, it disappeared. I don’t know if others are having this problem, though. Would you care to provide a link to the survey?

  4. 4 Babak

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    Kristjan, I can’t provide a direct link to the survey but when it pop-up on the right hand bottom corner of the screen you can select yes/no - so if it went away you either clicked no or just ignored it for more than 20 seconds.

  5. 5 jezza

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    A battle is a good way to describe, it implies a conflict between 2 equal forces perhaps, net result, the market goes sideways for a considerable period of time, neither bull nor bear?

  6. 6 Grand Supercycle

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    A few days ago I suggested a counter trend rally was due.

    The more influential main trend remains bearish though.

    The equity global uptrend since March 2009 was a bear market rally contained within a much larger downtrend that started in 2000.

    According to my indicators the March 2009 lows will not hold.

    The proprietary indicators I use in my technical analysis can identify trend changes before they occur.

  7. 7 WimpyInvestor

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    Personally, I would add “Cheap Valuation” to the Bullish support list.

    Using extremely conservative SPY earnings of $80 for 2010 and 2011, the market is trading at less than 15 PE. With 10-year treasury yielding 3.3%, a 200% risk-premium for equities translates to 6.6% earnings yield, or 15.2 PE.

    Many bears are using 10-12 PE as the bottom in valuation, but these levels were only reached in periods of very high inflation (1970’s). If 10-year treasuries ever trade to 10-12%, I would sell all equities and lock in those bonds any day. But, we are not there (yet).

  8. 8 Ed M.

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    Slighly off topic - anyone know of a source of publicly traded companies that have recently emerged from Ch. 11?

  9. 9 JAC

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    Babak,

    Great article. You summarized what is going on. Very objective.

    Low volume rallies and high liquidity rallies come to abrupt stops. That is the concern I have. If we are heading into a slow growth environment, that will cut profit margins for companies and revenue growth will be minimal. That is a recipe for low PE. Add to that people got burnt twice in the decade, the incentive to invest comes at low PEs.

    I will agree with you intermediate term analysis, but stocks will go lower in 12-24 months. Macro trends are too strong and Obama’s big government mindset wouldn’t help anyone (except the unemployed for now).

  10. 10 Babak

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    JAC, low volume rallies are all we’ve had pretty much since March of last year. Most of that has to do with the retail investor not participating in the stock market.

    Earnings don’t really matter that much because it is P/E expansion or contraction that provides most of the return or loss in the stock market. Since we are mired in a secular bear market, expecting P/E expansion is just not realistic.

  11. 11 CityReactionary

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    The purely fundamental bears often aren’t traders (at least not profitable ones) - they would struggle to make money because, as we know “the market can stay irrational longer than you can stay solvent”. A good trader should be pragmatic enough to understand that it may make sense to be long when the fundamentals are bearish and vice versa. However, if you can find trades where the technicals and fundamentals agree, you (hopefully) have a great opportunity…

    Also very good point from Wimpy - talikng about P/Es without considering interest rates is meaningless!

  12. 12 Wes

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    Babak,

    You say “we are mired in a secular bear market”. I’m busy trying to figure out what to do next, so it may not matter to me, but presenting the evidence of the “secular bear market” would make a good topic one day if you take requests.

  13. 13 Babak

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    Wes, I thought I had already… repeatedly. Here are two that come readily to mind: Dow Jones Long Term Chart: Another Decade For Bear Market and The 18 Year Stock Market & Commodity Cycle

  14. 14 Wes

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    Babak,

    Thanks. I’m aware of these but was hoping you had something more substantive. There is no way to avoid the coming bear market in 2038 because the calendar says so.

    Ridiculous. I don’t think you really believe this.

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