AAII Survey, Today's Gap Up, Magazine Covers, BGZ Stopped Out (Ouch)

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I started this post yesterday and then part of it got deleted accidentally and then I got predisposed and didn't finish.

Well, the BGZ posted stop was hit yesterday for possibly the world's worst trade. The posted exit will be the opening price of 27.63 yesterday. If you were clever enough to set your own stop at better prices, then that's good. I wasn't so clever, however, I may just be clever (or dumb?) enough to get back in today with a stop a penny below today's low in BGZ due to the pretty nice, high volume shooting star right at major resistance that formed yesterday coupled with a bunch of intermediate overbought indications.

The evidence is starting to mount that the market is reaching an intermediate term overbought condition. I will try to cover a bunch of data in a video this weekend, but as funny as it seems, the market has gone from modestly oversold to significantly overbought without barely a breather in the space of just over 2 weeks. The S&P 500 approached the 1000 mark yesterday which based on some Elliott wave pattern interpretations would be an idealized ending topping point for this rally. Also as shown above, as the market move into the 1000-1040 range there is major horizontal resistance, the type which has led to pullbacks so far on this rally.

Other factors of note.....The top picture above is the most recent Newsweek cover. Thanks for letting us know. I'm sure the call will be timely as you and other fine mass media publications have such a good track record at early identification of economic and investment trends. (Hopefully you caught the sarcasm). For anyone who has not heard of the "Magazine Cover Indicator" you probably should google it when you have 5 minutes that you aren't going to use productively. While this is not as provactive maybe as some past notables, the magazines sell what people want to hear and believe. It is obviously yet to be seen if this will be added to the list of obviously stupid and dead wrong timing covers from the past, but it is interesting none the less.

Also shown above the AAII (individual investor) survey took a huge jump in bullishness this week and is now almost 2 standard deviations from its 1 year mean. Bearish opinion made a corresponding large drop putting the bull ratio at its highest level since last spring just prior to the May 08 market peak. The current level is not too extreme in the history of bull markets, but it is still enough to worry about a rally's legs for someone with a shorter term time frame.

The bottom chart shows a 60 min chart of SPY. I am just noting that yesteday was the 2nd biggest gap up in the recent 2-3 week rally. Seeing as there was lack of follow through during the day, a close below the open, approach of major resistance, and extreme short-term overbought conditions, this may be an exhaustion gap. They typically occur at the end of an advance and occur in conjunction with a "news" item (in this case unemployment data). IF it is, then prices will probably close below that gap in the next day or two. I'm not necessarily saying this will be a major top, but it sure seems like some significant consolidation or give back will have to happen to refresh interest from the smart money.

I'm still awaiting a legitimate oversold signal on the SDS trade to post an exit there.

Surveys Showing Large Decrease in Bearishness

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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.

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This chart is a screenshot from Sentimentrader.com 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.

Pete

New All Time High in AAII Bearish %

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The chart above is a screenshot from Sentimentrader.com showing the last few years of data of the bearish respondant percentage from the weekly American Association of Individual Investors survey. Notice the huge spike below the green lines on the most recent reading. The scale is inverse so the large drop on the cahrt is actually a large increase in bearish outlook. The current reading is the highest ever in the history of the survey. The next highest reading was in 1990 and occurred just a few days after the bottom of a major leg down in 1990 where the market lost about 20% in 3 months. Taken together with all the other studies showing extreme pessimism, I have to feel more confident that a tradable bottom will occur in the next few days.

This morning we are getting another huge downer which has taken us down (as I type this) to the 127.2% retracement % of the Nov-Jan rally that I have noted in previous posts as the top of what I see as the major reversal zone for this bottom. From the looks of the charts, it seems that a move down to the lower end of the 660-690 zone (or a little further) may occur pretty quickly from this point.


Pete