Contrarian Take: Did Doomsday Prophets Scare the Bear?

Bears are powerful creatures, but they can get scared easily and may suffer from a fear similar to stage fright. Many media outlets have reported sightings of bears, but when everyone expects its appearance, it fails to show.

Baron Rothschild’s famous adage, that the time to buy is ‘when there’s blood in the streets’, is timeless.

History has also shown that the old adage is reversible, meaning that the time to sell is when there’s no sight of ‘blood in the streets’ or extreme optimism.

Is there extreme optimism right now?

Allow me to introduce my very own, non-scientific media sentiment indicator.

A couple of weeks ago value investing icon Jeremy Grantham published his first quarter 2014 newsletter. The topic was a statistical approach to market bubbles.

The Glass Half Empty Interpretation

According to the letter, Grantham believes that the S&P 500 will form a bubble that will eventually burst. The conclusion in his words is as follows:

“But I believe it [the bubble] will not end for at least a year or two and probably not before it reaches a level in excess of 2,250 on the S&P 500 (SNP: ^GSPC). I am not saying that this time is different. I am sure it will end badly.”

The financial media (not sure if they read the entire report or not) spun the following headlines out of Mr. Grantham’s analysis:

“Jeremy Grantham on Bubbles: ‘I am sure it will end badly’” – Wall Street Journal
“Jeremy Grantham: Stocks set to crash around November 2016” – Moneynews
“When Jeremy Grantham sees bubbles, it’s worth paying attention” – The Globe and Mail
“Jeremy Grantham makes a very specific call about when the bubble will burst” – Business Insider

This may have gotten lost in translation, but Grantham ‘predicted’ two developments:

  1. The S&P 500 will rally to 2,250
  2. It will end badly

Yet, I could not find a single article that even mentioned, let alone highlighted, S&P 2,250, which is a pretty bold call.

In fact, bearish financial headlines were so pervasive in early May that Yahoo Breakout ran a segment called: “The boys who cried wolf: Crash prophets on the rise.”

Is someone (hint: media) trying to spill blood on the street?

It Happened Before

This environment reminds me of what we saw about a year ago, when I wrote in the March 10 Profit Radar Report that:

The Dow surpassed its 2007 high and set a new all-time high last week, but investors seem to embrace this rally only begrudgingly and the media is quick to point that stocks are only up because of the Fed. We know this is a phony rally, but so does everyone else. We know this will probably end badly eventually, but so does everyone else. The market likes to fool as many as possible and it seems that overall further gains would befuddle the greater number.”

My research (S&P 500 2014 Forecast, published on January 15, 2014, available to subscribers of the Profit Radar Report) proposed a rally towards S&P 1,950 followed by a 10%+ correction back in January.

However, the recent spell of bearish headlines (caused by sideways trading not a correction) made me suspicious. It was time for the market to fool the crowded trade again. I proposed this head fake scenario in the May 7 Profit Radar Report (S&P was as low as 1,860 that day):

“The weight of evidence suggests the onset of a larger correction in May, but we are not the only ones expecting a correction. A false pop to 1,900 – 1,915 would shake out the weak bears and set up a better opportunity to go short.”

We got an S&P 500 (NYSEArca: SPY) pop to 1,902.17 on May 13, but the headlines continue to be bearish. We’ll have to see if the pop was enough to fool the bears and set the stage for a deeper correction.

I will be looking at key support and resistance levels for valuable directional clues.

The most important near-term support/resistance levels are disclosed here for free:

S&P 500 Analysis: The ‘Chopping Zone’ Explained

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

New Indicator by Stanford University Measures Media Sentiment

Astute investors have commented on the contrarian correlation between the media’s take on the stock market and the stock market’s performance. Now there is an actual index that keeps a pulse on the media’s sentiment.

Stanford University constructed a new index that gauges media sentiment.

I’m a ‘headline junkie’ and couldn’t wait to chart the raw data of the university’s Equity Uncertainty Index. Here’s a thumbnail rundown on the index:

Equity market related uncertainty is measured through an analysis of new articles containing terms related to equity market uncertainty. Terms are subdivided into three ‘theme buckets.’

1) Uncertainty or uncertain.
2) Economy or economic.
3) Equity market, equity price, stock market or stock price.

To be included by the index, an article must include at least one word of each bucket.

Searched are about 1,000 newspapers (via a NewsBank database) throughout the United States. Newspapers include large national papers like USA Today and small neighbor papers.

The number of newspapers NewsBank covers increased from 18 in 1985 to 1,800+ in 2008. To adjust for the growth, the index normalizes the results to an average value of 100.

Interestingly, according to the University, the index has a contemporaneous daily correlation with the VIX (Chicago Options: ^VIX). The data and Equity Uncertainty Index goes back to 1985.

As the chart below shows, the index is rather noisy, even when illustrating the 30-day simple moving average (SMA). Of course, it’s always tricky to cram 28 years of data into a five-inch chart.

The second chart cleans up the Equity Uncertainty Index a bit and plots it against the S&P 500. For this chart we’re looking at the 90-day median average since the year 1999.

Now we are starting to see a basic correlation between media reporting and stock market action. As with most sentiment indicators, the media’s reporting bias is deeply contrarian.

Big spikes in ‘uncertainty’ – much like the VIX ‘fear’ Index (NYSEArca: VXX) – generally mark a major market bottom.

Complacency, or the lack of uncertainty can (but don’t have to) be trouble for the S&P 500 (NYSEArca: SPY) and the broad market.

I look at headlines every day and compose my very own, non-scientific media index.

For example, below is my observation published in the March 10, 2013 issue of the Profit Radar Report:

“The Dow surpassed its 2007 high and set a new all-time high last week, but investors seem to embrace this rally only begrudgingly and the media is quick to point out the ‘elephant in the room’ – stocks are only up because of the Fed. Below are a few of last week’s headlines:

CNBC: Dow Breaks Record, But Party Unlikely To Last
Washington Post: Dow Hits Record High as Markets are Undaunted by Tepid Economic Growth, Political Gridlock
The Atlantic: This Is America, Now: The Dow Hits a Record High With Household Income at a Decade Low
CNNMoney: Dow Record? Who Cares? Economy Still Stinks
Reuters: Dow Surges To New Closing High On Economy, Fed’s Help

We know this is a phony rally, but so does everyone else. We know this will probably end badly eventually, but so does everyone else. The market likes to fool as many as possible and it seems that overall further gains would befuddle the greater number. Excessive optimism was worked off by the February correction. Sentiment allows for further gains.”

Looking at the chart, we see that the media is somewhat, but not extremely complacent.

I wouldn’t use this indicator as a timing tool, but it’s a fun study and potential warning.

Other sentiment and money flow indicators on the other hand are very powerful and have correctly foreshadowed market tops and market bottoms. With stocks at all-time highs we’re scouting signs for a market top.

This article is long enough already, but you may check out what other sentiment and money flow indicators ‘say’ about the potential for a looming market top. Here is: A Detailed Look at 5 Different Sentiment Gauges

Simon Maierhofer is the publisher of the Profit Radar Report.

Follow Simon on Twitter @ iSPYETF

Exactly How Worrisome is Bullish Sentiment?

Contrarian investors love to use sentiment as a general overbought/oversold measure. There’s no denying that Wall Street and Main Street have surrendered to the allure of higher prices, but just how much of a threat does bullish sentiment pose right now?

If you have skin in the game, you probably know something about the game.

If you have money invested in stocks, you probably have noticed the increasingly bullish forecasts.

Sentiment is a valuable contrarian indicator, but exact danger levels are difficult to quantify. How worrisome is the current bullishness?

Inverse Contrarianism

We saw a rare phenomenon in early January. Investors turned bullish, but the media publicized the bearish implications of bullish investors.

The January 13, Profit Radar Report pointed out the following: “Last week’s most notable development is the uptick in investor optimism. This normally contrarian development is tapered by the unusual media attention.

A headline on the Yahoo!Finance homepage reads: ‘Is the crowd’s cheery mood reason to fear the rally’s end?’ CNBC published articles such as: ‘Why the VIX’s recent plunge may be bad for stocks’ and ‘Where is the wall of worry?’

A contrarian indicator with so much mainstream attention is not contrarian anymore. Hopefully a continued move (perhaps through a laborious process) to around 1,490 will silence the contrarian publicity and better align overall sentiment with our upcoming technical short setup.

Market Silenced the Media

The S&P 500 has rallied 40 points since mid-January and did indeed silence suspicious media outlets.

Now we see headlines like these:

CNBC: Market Bears on The Brink: ‘I Can’t Fight Anymore’
CNBC: S&P 1,500: Last Barrier Before New Record
Reuters: The Great Rotation: A Flight to Equities in 2013
Bloomberg: Nouriel Roubini Faces the Music: Did Dr. Doom get it Wrong?

This is the most bullish I’ve seen the media in well over a year, but admittedly my self-composed “Headline Sentiment Index” lacks the trackability needed for a good indicator.

Other sentiment gauges do have a long track record and the Profit Radar Report takes a detailed look at four of them every month.

Below is the January 2013 Sentiment Picture (the Profit Radar Report prepares one detailed Sentiment Picture per month for subscribers on record).

Like gauges in your car’s instrument cluster, the monthly Sentiment Picture provides a quick summary of what’s going on.

Illustrated are the CBOE Volatility Index (VIX), Equity Put/Call Ratio, the percentage of bullish advisors/investors polled by Investors Intelligence (II), and the American Association for Individual Investors (AAII).

Shaded red areas denote the minimum/maximum sentiment extremes seen at prior highs.

Here’s a quick rundown of the four indicators:

The VIX is in danger territory (red box).

The Equity Put/Call Ratio is not per say in danger territory, but not far away from where a market top could be.

The percentage of bullish advisers polled by II is getting in the red danger zone.

The percentage of bullish investors polled by AAII is in the red zone.

Summary

Investor enthusiasm is high enough to where it could cause a sizeable correction, but not extreme enough to force a turnaround. A break below support would probably elicit more selling.

And one thing is for sure, there are plenty of buyers that could turn into sellers and drive prices lower. The Profit Radar Report pinpoints the support levels that, once broken, will cause more selling.