Reversal Time?

There's an old market saying that positions tend to match convictions. If investors are bullish, it's (naturally) assumed that they are betting on the upside, and vice versa.

However, if things reach a point where too many are positioned in the same way, especially where price trends have reinforced those views, it has often set the stage for a sudden and occasionally violent move in the other direction. That's one reason why many market-watchers try to keep tabs on sentiment.

While the relationship between what people say and what they do has been somewhat undermined by the unprecedented interventions of the Federal Reserve (and other authorities) in various markets, the wild market gyrations of the past decade, and a growing cacophony of commentary about where prices are headed next, that doesn't mean traditional sentiment gauges no longer matter.

Most likely, it means that the bands that have historically marked optimistic or pessimistic extremes have either widened out or, in the case of the "Bernanke Put"-type equity market environment we have now, shifted upwards.

Still, while caution is warranted when it comes to assessing the significance of any one indicator, when you reach a point where a growing number of them are telling a similar story -- even if some haven't quite hit their "new normal" extremes -- then it tends to confirm that too many in the trading crowd are leaning the same way -- and that a contrarian reversal is at hand.

With that in mind, it's hard not to read the following reports (and accompanying graphs) as anything other than a sign that the current rally is on very shaky ground -- especially when expectations are as high as they are that the Fed and/or the ECB and/or China and/or Apple will do or say something positive for stocks:

"This Is The Most Bullish Moment We Can Recall Since The Financial Crisis Ended" (Business Insider)

Markets are down a hair today, but the theme of the morning is clear: Uber-bullishness. Everywhere.

This is the most unanimously bullish moment we can recall since the crisis began.

Note that this comes as U.S. indices are all within a hair of multi-year highs, and the NASDAQ returns to levels not seen since late 2000.

"Late-Stage, High-Risk" (Hussman Funds Weekly Market Comment)

For investors who don’t rely much on historical research, evidence, or memory, the exuberance of the market here is undoubtedly enticing, while a strongly defensive position might seem unbearably at odds with prevailing conditions. For investors who do rely on historical research, evidence, and memory, prevailing conditions offer little choice but to maintain a strongly defensive position. Moreover, the evidence is so strong and familiar from a historical perspective that a defensive position should be fairly comfortable despite the near-term enthusiasm of investors.

There are few times in history when the S&P 500 has been within 1% or less of its upper Bollinger band (two standard deviations above the 20-period moving average) on daily, weekly and monthly resolutions; coupled with a Shiller P/E in excess of 18 – the present multiple is actually 22.3; coupled with advisory bullishness above 47% and bearishness below 27% - the actual figures are 51% and 24.5% respectively; with the S&P 500 at a 4-year high and more than 8% above its 52-week moving average; and coupled, for good measure, with decelerating market internals, so that the advance-decline line at least deteriorated relative to its 13-week moving average compared with 6-months prior, or actually broke that average during the preceding month. This set of conditions is observationally equivalent to a variety of other extreme syndromes of overvalued, overbought, overbullish conditions that we've reported over time. Once that syndrome becomes extreme - as it has here - and you get any sort of meaningful "divergence" (rising interest rates, deteriorating internals, etc), the result is a virtual Who's Who of awful times to invest.

"Investor Sentiment: Don’t Become Roadkill" (The Technical Take)

The “Dumb Money” indicator (see figure 1) looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investors Intelligence; 2) Market Vane; 3) American Association of Individual Investors; and 4) the put-call ratio. This indicator is bearish, and just above the extremely bullish level.

Figure 1. “Dumb Money”/ weekly

Figure 2 is a weekly chart of the SP500 with the InsiderScore “entire market” value in the lower panel. From the InsiderScore weekly report: “We continue to see moderately high levels of selling across the market but as we noted last week, from a historic perspective the volume of activity is not particularly egregious. Nonetheless, there is obviously far greater conviction amongst sellers as compared to buyers as the quality of buying events has been generally poor over the past several weeks. “

Figure 2. InsiderScore “Entire Market” value/ weekly

Figure 3 is a weekly chart of the SP500. The indicator in the lower panel measures all the assets in the Rydex bullish oriented equity funds divided by the sum of assets in the bullish oriented equity funds plus the assets in the bearish oriented equity funds. When the indicator is green, the value is low and there is fear in the market; this is where market bottoms are forged. When the indicator is red, there is complacency in the market. There are too many bulls and this is when market advances stall. Currently, the value of the indicator is 71.55%. Values less than 50% are associated with market bottoms. Values greater than 58% are associated with market tops. It should be noted that the market topped out in 2011 with this indicator between 70% and 72%.

Figure 3. Rydex Total Bull v. Total Bear/ weekly

"Cash No Longer King? Investors Buying Stocks Again" (CNBC)

Cash levels in portfolios have fallen to a 15-month low, according to one survey that suggests a thawing in investor sentiment even as the market enters its historically worst month.

As the Standard & Poor's 500 added another 2 percentage points in August to its 12 percent year-to-date gains, investors dropped cash levels to 18.1 percent of their portfolios, the lowest since May 2011, a poll from the American Association of Individual Investors showed.

The shuffling coincided with a 0.7 percentage point increase to stocks to 60.5 percent of total portfolios, and a 2 percentage point increase to bonds to 21.4 percent.

The moves represent respective four- and six-month highs and come as September, with its traditionally negative returns, looms.

"How Hated Is This Rally?" (The Big Picture)

The objective measures shown below like the Investor Intelligence survey (first chart below), the VIX (second chart below) and the Commitment of Traders report (third chart) show nothing even close to what the article contends. If anything, this rally is getting overbought because of too much optimism.

Comments

[Roger]

I have seen all this and while I agree that sentiment is very bullish but you miss the following key points: 1) market participation by dumb money is very low as over $1T has flowed out of equities and squarely in to the MOAB or mother of all bubbles the bond market for perceived safety 2) Investors intelligence is all news letter writers and does not mean that people are acting on the information 3) the Vix is a reactive not a predictive indicator 4) the put to call ratio has not been excessively complacent. Now given all the above I might agree but what gives me pause is the incredibly crowded trade of NYSE Short interest. For the past several weeks the short interest ratio has been climbing and for 12 consecutive days the NYSE short interest ratio has hit a new 5 year high. This is real money at risk not newsletter writers and I would also argue that it is where the dumb money is vs the dumb newsletter writers. This market climbs as no one believes it which is not uncommon for a bull market and while the economy stinks right now stocks are forward looking and that is why they may out perform even when the economy looks dismal at present. My two cents

[Tom]

Well said, both of you. Cogent analysis of the steady deterioration of the economy, continued destruction of the biosphere and the ongoing collapse of civilization. The cheap energy is gone and there isn't enough time or money to fix the electrical grid, so there is no "in the long run" any longer. Our days are numbered as the resources run out (especially potable water) and it becomes increasingly hard to grow food enough for the 7 billion inhabitants. If current trends hold, and there's no reason to think otherwise since we fail to change our ways despite all the climatic calamity going on around us, it won't be long til there is no spring. It will just go from "somewhat cooler" for 3 to 5 months HOT for 4 - 7 months, and maybe DRY too (like for DECADES). One thing's for sure, a lot of species won't be able to adapt to the stress and rapidity of constant to accelerating change.

[Rocky]

I have never put much faith in technical analysis. Right now I am much more concerned about whether there is going to be another war in the Middle East involving the US in a significant way way. Wars are very destructive of wealth.

[emma]

Wow! Thanks for the post...great charts there.

I just check that VIX chart for you guys, and can tell you that it has triggered a BUY signal just now on DAILY, and also weekly! So what do you think that means for the market :) very very....interesting.

More Chart Porn here :) - The Sentiment Trader

[emma]

http://http://sentiment-trader.blogspot.com.au

[roger]

Time will not and cannot go in reverse gear.
Bottom line is the global export market, it is now in free fall, from Canada,Australia,
Europe, China and the USA, the export game is over,and the lights are being turned off in factory after factory in all nations. Wall Street is only a big circus show whose tent will blow up in flames at any moment. A world divided by self interest is on automatic self destruct mode.

[Pump it up]

MF Global On Steroids
But the market continues to be hampered by a lack of collateral. And if banks and big investors can't post collateral for margin calls, the whole global Ponzi house of cards will collapse. In order to address this, Wall Street had to figure out a way to repackage crap assets so they could be utilized as collateral that could be posted against extremely risky OTC derivatives positions. Ergo, "collateral transformation." Just let that term roll around your tongue and the right side of your brain for a few moments. It's such a grandiose and exalting term. Like, the geniuses on Wall Street are going to metamorphize good collateral out of bad.

The way it works is that "collateral transformation" desks at the big bank will take crappy assets from big investors who are required to post more collateral against losing derivatives positions and exchange them for Treasuries. The crap assets will be assessed some kind of discounted value, so if you need $100 million in Treasuries to post as collateral, you might have to come up with $120 million of "assessed" value in the crap assets. Does this sound at all familiar? Hint: AIG, Bear Stearns, Lehman, etc.

In reality, "collateral transformation" is just fancy name for hypothecation. In other words the big Wall Street banks will find Treasury bonds that can be posted as collateral and charge the counterparty a nice fee for this. Theoretically the Treasuries can't come from customer accounts, but we saw with MF Global just how rigid this law turned out to be. This is adding another layer of hypothecation in the financial market Ponzi scheme, only the collateral being posted to "back" the hypothecated Treasuries will crater in value in a bad market and there will be massive losses. The fact is, Wall Street has taken the MF Global/JP Morgan model for collateral posting and injected it with steroids. You can thank the Obama Government for enabling and allowing this.
http://truthingold.blogspot.com/2012/09/mf-global-on-steroids.html