Thursday, May 7, 2009

Surveys Showing Large Decrease in Bearishness

Click on Chart to Enlarge

This week's results of the Investor's Intelligence and American Assoc. of Individual Investors surveys show a large decrease in bearish opinion. In fact, the current levels are near the lowest bearish opinion since the beginning of the bear market.

The chart above is the II bearish opinion survey with some standard deviation bands that help to put the data into context. Notice that the bearish % is now just a little above 30%. The last reading this low was last year around this time as the market approached the peak of its 44 day rally off the March lows. Also, notice that the current reading is below the standard deviation band which nicely marked the top this January.

Click on Chart to Enlarge

This chart is a screenshot from of the AAII bull ratio (bulls/(bulls+bears)). The red dotted lines are 1.5 standard deviations from the 1 yr average reading. Notice that the current reading has just hit that red line. That standard deviation band has been a good guide for locating market peaks in this bear market with comparable readings this January, late last October, and the middle of last May. This reading is largely due to a big decrease in bearish %, but the bullish % has also risen substantially.

So, for about 3 weeks we have been seeing real money gauges from put/call ratios, Rydex fund flows, Nasdaq mini futures long positions, etc, reaching into "excessive optimism" territory. Now, we are seeing a noticeable increase in comfort with the market's prospects by both individual investors and investment advisors. To help confirm this other dataI, would like to see a sizeable increase in call buying and decrease in put buying from small lot orders when the data comes out this weekend. Also, while I have not discussed this on the blog, stocks are largely overvalued relative to bonds on a statistical basis currently. This type of relative valuation model is very helpful in indentifying price extremes against the long term trend (200 day MA).

In any case though, if this is truly a bear market rally, I have to expect that the market will begin to pullback within the next week or two. If new highs continue into June, then that would call things into question for me on the longer term outlook.

I wrote the previous part of this post this morning, but am just publishing now after the close. Today looks like a pretty classic reversal day. The candlestick patterns are very solid bearish engulfing patterns on the index ETFs. XLF ended with a high volume dark cloud cover off of a very large gap up. Take a look at SMH (semiconductors ETF)! It engulfed the real bodies of the last 5 trading days and marked the largest down day since near the bottom of the bear market. When those days occur coming off of highs, it usually indicates a trend change. Many energy stocks showed very wide range engulfing patterns on heavy volume. XHB (housing) broke its uptrend by completely retracing the last swing move to new highs.

The BGZ trade is off to a good start, but the short-term model for the S&P 500 is not yet oversold. Just maintain the current sell stop at 36.40, but I won't blame anyone for moving a stop to breakeven, particularly if there is a gap down tomorrow. This reversal looks "real", so my plan is to reduce risk ASAP but hope to catch what may be a large move down in the markets, which would make a huge gain on BGZ if this reversal sticks.

A buy the rumor - sell the news top seems almost too scripted here, but there is a plethora of supporting evidence for a significant pullback any day now. So let's keep the stop as loose as is sensible for now considering that even if stocks "just" pull back to the 50 day MA, the reward could easily exceed 6 times the current risk with the stop at 36.40.


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