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You Call That a Correction? at Trader’s Narrative

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I know we’re in a bull market, but come on! You really expect me to label that as a correction? From 1540 on the S&P 500 to 1490? A mere drop of 50 points? a decline of 3.2%?

Sure, last Thursday we saw some really horrible breadth on the NYSE. The proverbial Lowry’s 90-90 day. Breadth was atrocious. But the indices themselves fell minimally. The S&P 500 fell 1.76% and the Dow Jones only 1.5%. Not the sort of price declines that normally accompany a 90-90 down day.

As I’ve been harping on about, the breadth wasn’t horrible due to across the board and intense selling but instead caused by the bond market. The fall in the bond prices spilled over into the interest rate sensitive non-common stocks on the NYSE and voila! historic breadth extreme.

So can you really call last Thursday as a 90-90 down day? I would argue no.

As I look across the market landscape, I don’t see a lot to get excited about. A lot of the indicators I look at are either stuck in neutral or signalling a toppy market. I have no idea where we are going next but I don’t have a lot of conviction that it will be another upleg.

Gentlemen Prefer Bonds
For one, the bond market usually throws a monkey wrench into the works when the monthly rate of change of yield reaches 9%. And I see no reason why this time it could be different. Unless we have a bond market rally as fast and sharp as the decline.

The sentiment picture is mixed with only one measure showing any real reason to be bullish. Others (like AAII) are middle of the road and others yet (II) are showing too much bullish sentiment.

Put/Call Ratio
It is fine and dandy to check in on how people are feeling about the market, but what really matters is what they are doing. Option data shows that for the most part, the bulls have little to cheer about. The CBOE put/call ratio for equities is way too low. In fact, if we zero in on retail investors (”dumb money”) we find them to be surprisingly piling into calls right now.

Odd Lots
Another way to measure how the small investor is actually positioned is to look at odd lot purchases (less than 100 share). Again, surprisingly, we find that odd lot purchases are through the roof! Small investors and traders are buying with both hands. You have to think long and hard before joining this crowd, instead of taking the other side of their trades.

Short Shorts
By now, you probably won’t be shocked to learn that the same public that is buying more calls than puts, buying odd lots by the barrelful is eschewing the short side. This data comes with a two week delay but it shows how many shorts were made by specialists and how many by the public on the NYSE. The idea is that you want to side with the insiders and not the public.

One of my favourite internal metrics is the percentage of stocks above moving averages. In one glance it shows you how many stocks are above their historic average price. Stretch too far away from the average and you’re probably going to see a counter trend snap back. Right now things are ho-hum. They have come down a little bit due to last week but haven’t reached levels at which we can call last week’s price action a correction. Or setting up a low risk entry point for longs.

New Highs and Lows
One last indicator (I could keep going for hours ;-) ): the ratio of new highs to new lows. For the NYSE this indicator fell to the same level as in March 2007. But for the Nasdaq, it is middle of the road, ho-hum, neutral. This is a very reliable indicator for finding oversold levels and right now it isn’t showing oversold, except as it relates to bonds and interest rate sensitive issues. The ideal is to find both the NYSE and the Nasdaq new high/new low readings confirm each other.

To conclude, I’m seeing more reasons to be cautious than to be bold. No one knows what the market will do but by working an edge, all we can do is put probability on our side.

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4 Responses to “You Call That a Correction?”  

  1. 1 Prospectus

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    Nice analysis, Babak. Please, keep going for hours!

    Where do you look at the odd lot purchases? How can you tell that that the odd lots are buys or sells by small investors? Thanks.

  2. 2 Babak

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    the information comes directly from the NYSE. You can also get it through various technical analysis services like sentimentrader or decision point, etc.

  1. 1 Stock Market Recap for June 20, 2007
  2. 2 Bear Stearns & the Subprime Meltdown

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