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

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