Why I don't think we've seen the low yet

The market sold off again today. While volume wasn’t strong, breadth was decidedly negative. Last week’s highs and lows are being watched by many as potential support and resistance levels.

Most bullish arguments I’ve seen lately depend strongly on sentiment measures, so I thought I’d share my feelings on these sentiment measures with you today.

Market sentiment can be measured in a number of different ways. In general, all sentiment indicators are basically measures of fear or complacency in the market. Historically, when fear has risen to extreme levels, that has led to very favorable market conditions and explosive rallies. When people are bearish and fearful of the market, they tend to take their money out and park it in cash or other instruments. Sentiment measures hitting extreme levels means that an inordinate number of people are bearish. In other words, they are fearful of the market and have gone to cash. Since so many people are bearish and effectively out of the market, there is no one left to sell and push prices lower. At the same time there is a large amount of cash on the sidelines which could help propel the market if things begin to turn and everyone who was bearish and out now decides they want back in. This is why extremely negative sentiment reading many times will lead to rallies.

Currently there are many sentiment readings that are at or near extremely bearish levels. These would include Investors Intelligence survey, Put/Call Ratios, Rydex Asset Ratios and others. Additionally, some overbought/oversold indicators such as the Arms Index and the McClellan oscillator have also shown some readings that looked like the market was/is extremely oversold. Looking at some of the sentiment indicators would lead one to believe that the investing public has turned so negative on the stock market that it is bound to rally. I am not sure that is the case.

While the selloff the last month or so has been fairly strong and likely scary to those that are in the thick of it every day, has it been enough to truly worry the general investing public? I doubt it. The S&P 500 in my eyes is the most important index for investor sentiment. It has the most money indexed to it, and therefore best represents the performance of most people’s long-term stock investments (i.e. 401k). The S&P 500 still has not undergone any type of serious correction. From high to low over the last six weeks it dropped about 8%. This is not the kind of number that will scare most people with longer-term horizons. The lows of last week were merely the lowest levels the market has seen in the last seven months. In other words, most investors that have been putting money in over the last few years are still solidly in the black. You’re in the black if you began investing last summer. So what is so scary?

My feeling is that volatility has been so low for so long that many “traders”, as opposed to non-trading investor-type market participants, have been caught off-guard by the recent volatility pickup. The selloff was something traders haven’t seen for a while and it spooked them very quickly. I believe the sentiment indicators are a better measure of “traders” sentiment than “investing public” sentiment. Therefore, I have serious doubts that a true washout has occurred. I don’t believe the public has turned as bearish as the sentiment gauges are showing, and I believe we could have significantly more downside before the true market fear kicks in that would create the big washout.

What could help change my mind? Strong buying on strong volume combined with breakouts of basing formations and apparent emerging leadership. I’m still not seeing any of that. Therefore, my bias remains the same. I am trading in bear-market mode.

Best of luck with your trading,

Rob Hanna

robhanna@comcast.net

For those who may be looking to expand their knowledge beyond just market timing, my Hanna ETF Money Flow System utilizes the VIX in generating trading signals for spread trades.

Rob Hanna is the principal of a money management firm located in Massachusetts. He has spent the last several years developing and refining methods for trading in stocks across multiple time frames. He selects stocks using both fundamental and technical criteria, and then trades them using technical analysis techniques.