Surprising Bearish Sentiment Extremes are Popping Up

Stocks have been trading in a tight range near all-time highs, but an increasing number of investors wouldn’t want to touch stocks even with a ten-foot pole.

This is somewhat unusual, but is it bullish for stocks?

Here are three sentiment gauges worth noting, and how to make sense of them:

  1. The percentage of retail investors polled by the American Association for Individual Investors (AAII) has shriveled to the lowest reading since April 2013.

    The chart below plots the S&P 500 (NYSEArca: SPY) against the % of bullish investors. The red lines mark similar levels, and how such readings affected the S&P 500.

  2. The four biggest index ETFs – S&P 500 (NYSEArca: SPY), Nasdaq QQQ ETF (Nasdaq: QQQ), iShares Russell 2000 (NYSEArca: IWM), Dow Jones Diamonds (NYSEArca: DIA) – suffered $16 billion worth of withdrawals in April, one of the worst months (for index providers) on record.
  3. According to the Commodity Futures Trading Commission’s (CFTC) commitment of traders (COT) report, the ‘smart money’ has reduced short equity exposure while ‘dumb money’ is selling stocks.

When viewed in isolation, the above-mentioned sentiment developments are bullish for stocks. However, they are contradicting the bearish message conveyed by seasonality and market breadth.

For now, we probably shouldn’t blow such bearish sentiment messages out of proportion. Stocks are still stuck in a range, and the contradiction between indicators may just perpetuate the range, or stretch it.

I would watch S&P 2,118 as line in the sand. A break above 2,118 would likely reel in buyers. Although it may not be long before ‘buyers remorse’ sets in again.

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 and 17.59% in 2014.

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

 

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Two Sentiment Gauges Reach Multi-Year Bullish Extremes

It’s been a while since we’ve seen bullish sentiment conditions, but this week’s rally pushed two sentiment gauges to multi-year extremes. But, there is reason to view the two extremes in context with the larger sentiment picture.

We looked at various sentiment measures in April and May, and the common denominator was that investors were unusually bearish.

As happens so often, bearish sentiment turned into bullish price action (for an insightful read on foolishly bearish forecasts click here: Hey Bears! Where is the Promised Crash or Correction?).

Thanks to the cycle of sentiment mean reversion, rising prices (since late May) lifted bullish sentiment. In fact, two sentiment measures reached multi-year extremes this week.

One particular gauge that foreshadowed a stock market rally back in May was the CBOE Equity Put/Call Ratio.

The May 14 and 18 Profit Radar Report featured this chart of the equity put/call ratio and stated: “Prior corrections were preceded by a put/call ratio around 0.5 or below. Today the put/call ratio is at 0.72, a level that’s indicative of a low more than a top. The equity put/call ratio cautions of further up side.”

The second chart updates the equity put/call ratio and plots it against the S&P 500. On Wednesday the equity put/call ratio dropped to 0.43, the lowest reading sine January 2011.

In addition, the percentage of bullish investment advisors polled by Investors Intelligence rose to 62.2%, the second highest level in the survey’s history.

Readings above 60% generally result in a rally pause or correction. However, the survey’s all-time high water mark (62.9%) occurred in December 2004 and didn’t cause too much trouble.

The equity put/call ratio is more worrisome as it indicates very limited hedging activity. This means many investors are long and naked (long without put protection). If the S&P 500 starts falling, they have to sell their core holding.

I always look at more than just two sentiment gauges. A broadening of the sentiment scope reveals that other gauges are still in neutral territory (retail sentiment, CBOE SKEW Index, etc.).

Once a month, the Profit Radar Report publishes a comprehensive sentiment picture that plots six sentiment gauges against the S&P 500. The May 23 Sentiment Picture proposed that: “The market will grind or spike higher (whichever is necessary to turn more investors into bulls) before delivering a noteworthy correction.”

Clearly the S&P 500 (NYSEArca: SPY) has succeeded in turning many more investors into bulls. Whether it’s been enough to cause a correction remains to be seen, but risk is rising.

What about stock market valuation? Are stocks too expensive and ready for a mean reversion?

Here is an objective look at four different valuation metrics and what they mean for the stock market.

Is the S&P 500 Overvalued?

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.

This Line is More Important for Gold Than the 200-day SMA

Back in December you couldn’t get investors to touch gold even with a 10-foot pole. From low to high, gold has rallied 13% since and analysts are starting to up their full-year targets. This could be a costly mistake.

About 50 days ago analysts gave gold a snowball’s chance in hades to move higher.

The December 2013 headlines below show that investors were as bearish about gold as they were bullish about the S&P 500 (NYSEArca: SPY).

Bloomberg: Gold’s drop to lowest since 2010 seen extending next year by Goldman Sachs
Forbes: Gold may be on verge of a waterfall-style decline
Wall Street Journal: Gold is testing last ditch support before it falls further into the abyss
Bloomberg: Gold trades below 1,200 as growth outlook curbs haven demand
Wall Street Journal: Gold’s glimmer gone, mutual funds feel the pinch

Those bearish headlines and other sentiment gauges contributed to this contrarian assessment by the December 29 Profit Radar Report: “Gold sentiment is very bearish (bullish for gold) and prices may bounce here.”

Up until February 11, gold’s rally attempts were feeble, with gains of less than 4% since the December 31 closing low at 1,204.

Gold broke free of its short-term technical shackles on February 12, when the Profit Radar Report noted: “Gold has broken above red trend line resistance (dashed red line), but has been held back so far by silver’s inability to move above 20.64. Odds favor higher gold prices as long as 1,254 holds.”

Silver confirmed gold’s move on February 14 (when it surpassed its prior highat 20.64), which helped gold jump above its 200-day SMA.

However, as the weekly long-term gold chart shows, there’s significant trend line resistance right around 1,335, which has kept a lid on gold’s rally.

The short-term daily gold chart illustrates additional short-term support/resistance levels. It also shows that RSI confirmed the recent rally high, which suggests new highs in the future.

However, any new highs could be short-lived. A thorough analysis of gold money flows – in particular Gold ETFs like the SPDR Gold Shares (NYSEArca: GLD) and iShares Gold Trust (NYSEArca: IAU) – strongly suggests that new lows for gold and silver are still ahead.

The article below reveals the reliable pattern that tends to accompany major gold bottoms. The Missing Tell-Tale Sign of a Lasting Gold Market Low

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.

Smart Option Traders ‘Smelled’ the Latest Bounce

The Volatility Index (VIX) has not lived up to its contrarian indicator reputation, but there is another CBOE options index that’s provided some noteworthy signals. Say hello to the options indicator of the future – the SKEW.

A pilot literally monitors dozens of controls to navigate the aircraft safely through the air.

Like a pilot, the Profit Radar Report constantly monitors dozens of different stock market gauges.

Once a month, the Profit Radar Report publishes the Sentiment Picture. Radar like, the Sentiment Picture searches for sentiment extremes.

Shown below is the May 2013 Sentiment Picture (published on May 19), which plots the S&P 500 against five different sentiment gauges:

1) CBOE VIX
2) CBOE SKEW
3) CBOE Equity Put/Call Ratio
4) Percentage of bullish advisors polled by Investors Intelligence (II)
5) Percentage of bullish investors polled by the American Association for Individual Investors (AAII)

After many months of average readings, the May Sentiment Picture finally showed some extremes. Most notable were the up tick in the SKEW and the drop in the equity put/call ratio.

Unlike polls, the equity put/call ratio is an actual money flow indicator. It showed that investors are putting their money where their mouth is and indicated that risk for bulls was rising.

The actual sell signal was triggered based on technical analysis on May 28 with a target of 1,594 – 1,598 for the S&P 500.

The sell signal proved correct, but it was in contradiction to a bearish SKEW extreme, which is generally bullish for stocks.

On May 28, the SKEW was about the only indicator that suggested higher stock prices. Although the SKEW is quite accurate (see green and red lines on the second chart) its message was simply overruled by the majority of bearish indicators (but its message was only tucked away, not forgotten).

The SKEW – an options-based index like the VIX – in essence estimates the probability of a large decline. A reading of 135+ suggests a 12% chance of a large decline (two standard deviations). A reading of 115 or less suggests a 6% chance of a large decline. In short, the higher the SKEW, the greater the risk for stocks.

The second chart plots the S&P 500 against the SKEW only.

A week later the lonely SKEW signal received backup by extremely bad breadth. Breadth was so bad, it’s actually good.

The June 6 article iSPYETF article noted a NYSE Advance/Decline Ratio that’s usually seen at market bottoms. Now there were two – the NYSE A/D ratio and the SKEW.

Both gauges have a good track record and on June 6 stocks staged a bullish intraday reversal after nearly touching the 1,598 down side target. It seems like options traders were the first to ‘know’ that a bounce was forthcoming.

A pilot is taught to always trust his instruments, not his instincts or emotions. Investment gauges aren’t as reliable as aircraft instruments, but investors should trust them much more than their own emotions. Does the bounce have legs?

The ‘instruments’ are telling me right now that stocks need to move above resistance (the lower lows, lower highs sequence has yet to be broken) or below support to trigger the next move. This may sound vague, but sometimes the market lacks clarity and when that happens it’s smart to stay on the sidelines.

It’s better to miss a trade than to lose money on a trade. The job of the Profit Radar Report is to spot and profit from high probability trades.