It’s mid June 2009 and I’m going to be arguing the case for the extreme Bear.
First let’s quickly review the market. From the high in October 2007 to the Low in March 2009 the SP500 fell nearly 58%.
To date (that’s early June 2009) the SP500 has retraced almost one third of that loss.
The SP500 has already recently tested the early January high which was the high for the year. Since that point public sentiment has become measurably more bullish. Actually to a level more typically seen at a market top and certainly the sort of level of bullish enthusiasm you would expect to see at the top of a bear market rally.
You’ve probably heard the phrase that “bull markets climb a wall of worry” – well there doesn’t appear to be much of a wall of worry left any more. At least as far as the retail investor is concerned.
And so, if this is a bear market rally, and I believe it is, then sentiment is fast reaching unsustainable levels.
But why am I so bearish? Why do I think this isn’t already a new bull market and we’re just due a normal kind of bull market correction? Why the meltdown scenario?
That’s a good question – and I want to answer that by showing you a chart. It may be the kind of chart you’re not familiar with so initially let me offer an explanation here.
This is an example of what I call a price-time chart. This chart shows a normal bar chart in the foreground which happens to be a 1 minute chart of the SP500-emini futures, and on the left the price-time distribution profile which shows how much time is spent at each price.
And you can see on this chart that most time was spent just above 930 – that’s the red horizontal line here. It’s a very important level because it shows you which price attracted the most time. And as you can see above, time is an important component in this formula that I’ll come back to in a second.
You can use these charts over any time period using any timeframe.
Here’s a chart covering a week’s activity using 5 minute bars and here you can see that most time was spent just above the level 940 over the period of that week. If you want to find out more about these charts then you should start by googling “Market profile” and start with the work of Peter Steidlmayer.
Here’s the point I want to make (here’s a chart based on hourly bars which covers a long period of time on the SP500 cash index, all the way back to 2003) – one of the useful things with this kind of chart is that we can let the chart tell use where value is according to the formula:
Price + Time = Value
That makes sense if you think it through.
Value is simply where the chart spends most time and with this type of chart you can see very clearly where value is and where value was at different times.
For example in 2005 the value line was just below the 1200 level. In 2006 it was about 1270 – you can see that very clearly.
The point is I have been following these charts, looking at these charts for many, many years and it is my contention, my discovery, that these value lines actually relate to each other.
There’s a relationship between the levels where these value lines emerge on the chart.
I’m not going to say any more about that in this video but currently where the SP500 is finding value, as far as I’m concerned at least, is very, very bearish.
It is not suggesting that the bear market finished at the March low. It is in fact suggesting that the March low is not low enough. Actually a move below 500 is what this chart is suggesting and that’s obviously a very bearish picture indeed.
So again, why the meltdown scenario? If the market is eventually going to go below 500 why shouldn’t it take all the time it wants to get there? Why not a low below 500 in say three years time?
The next chart shows what I believe is W.D. Gann’s Master Time Factor and again you should Google “W.D. Gann” for more information. I believe that Gann’s Master Time Factor is the 60 year cycle. And that’s what we’re looking at here.
The blue line shows the Dow from 1947 through 1949 and the brown line shows the Dow from 2007 to present. They are not identical I’ll grant you but to me they are very similar and I’ll tell you why. Look in the middle here at the “8” year.
Now a year ending in “8”, as any Gann analyst will tell you, is typically a strong year. Gann said this himself in the early part of the last century. If you look at charts of 1958, 1968, 78, 88, 98 you’ll see that typically they are strong years – but not 1948, it was unusually flat; and certainly not 2008 and that’s because I believe the sixty year cycle happens to be active.
I look at this chart and to me it strongly suggests a final low is yet to come and pretty quickly. By the way, in 1949, the low here was the ultimate low. The dow never went any lower than that.
So that’s my second piece of evidence, I have a lot of faith in this cycle and currently it’s making me very nervous for the market.
I mentioned earlier that the “Wall of Worry” had all but disappeared and I want to talk a little more about that and market sentiment.
A bull market requires pessimism, that’s kind of a contrarian statement – it requires a good stock of bears who are still available to turn bullish and provide more fuel (buying power) for a further rally. And it’s my contention that right now, mid June, that the fuel is running out.
So is this rally running out of steam? I would think so, yes. There’s a lot of bullish media at the moment; a lot of bullish sentiment; lots of investors coming back into the market right now, scared of missing the next big move which they have been told is up.
And in a bear market rally when you can measure extreme bullishness from the private investor you are probably looking at a top.
So let’s present some evidence of this “extreme bullishness”.
Here’s one of my sentiment charts. This indicator at the bottom here, compares total nasdaq volume to total nyse volume. We call it the Nasdaq/Nyse volume ratio. In fact this shows a 10 day moving average of that ratio, that’s the black line. So it’s a 10 day moving average of Nasdaq total volume divided by Nyse total volume and shown as a percentage. Speculative activity is more typical of the Nasdaq market than the Nyse and so this indicator tries to measures the amount of speculation currently in the market.
And you can see that the red colour on the index chart shows where the indicator (below) is above 150. You can see that when the indicator is above 150, the bars on the S&P index chart turn red.
And you can see clearly that it usually precedes a sell-off, and to my mind especially in a bear market. So if this is still a bear market of some larger degree, and this is a bear market rally, than this indicator being above 170 here is a big warning.
Here’s another sentiment indicator. This is the ISE Sentiment Index from the International Securities Exchange. This is an options ratio and I use their Equity-only options ratio. It’s a measure of Call volume compared to Put volume and the ISE exclude market maker and firm trades, so as they say on the website, it “allows for a more accurate measure of true investor sentiment than traditional put/call ratios”.
And I run a 10day moving average through the data, that’s the black line here, to smooth it out and as you can see, since the March low in the index, this indicator has been moving higher. Basically that’s bullish investor sentiment increasing fast as the market rallies. And, as you can see, by this measurement the public are more bullish than they were in January before the market sold off and more bullish than they were back in May 2008, once again before the market sold off.
You’ve probably heard of the VIX indicator, here it is. Often called the fear gauge, the SP500 volatility index is back in the mid twenties again having been in the high eighties last October. So not much fear at the moment relative to readings back over the last nine months.
A point to make here is that these indicators generally are considered contrarian indicators. We look for extremes in public bullishness or bearishness, the point being that at extremes in these readings it is usually a good time to fade, or go against, that sentiment.
The last indicator I’m going to show you, illustrating public sentiment, is my version of the Rydex Equity Funds Assets Ratio. This compares the assets of Rydex mutual fund investors. I take the total assets of a select number of bullish funds from Rydex and divide those assets by the total assets of a select number of bearish funds. That ratio is shown at the top there. This is a great sentiment indicator because it shows what investors are actually doing rather than what they are saying. And what they are doing at the moment is switching out of bearish funds and into bullish funds. You can see that because the ratio has recently climbed very rapidly to a level not seen since the market top in 2007.
So there’s recently been a big increase in public enthusiasm for the stock market.
But what about the smart-money: the commercial traders, the market movers, how bullish are they? Can we measure that sentiment?
This is my Smart-Money indicator number 1. This is based on Commitments of Traders data. Commitments of Traders data for the SP500 futures.
Just a quick explanation if you’re not familiar with this data. Every Friday the CFTC reports futures positions (in various markets) held by different groups. Here’s an old example of the report showing SP500 data. Believe it or not there’s a breakdown provided each week of the number of long contracts held and the number of short contracts held by each of these groups: Commercials, Non-Commercials and Non-Reportables (which is the small traders).
One of these groups is called Commercial. The Commercials are large concerns that use the futures markets to offset their risk. By analysising the Commercials net position (that’s their long contracts minus their short contracts) we can track their level of hedging and gain an insight into their current opinion of the underlying market.
The Commercials group is often called the “smart-money”. It is usually wise to follow this group especially when they become unusually long or short.
So back to the chart; the blue line represents the Commercial (smart-money) net position expressed as a percentage of total open interest.
So what is it telling us? It is telling us that the smart-money is bearish. And you can see that as the market rallied off the March low there’s actually been an increase in the net short position of the smart-money. They are at least as bearish as they were at the March low and they have not expressed an interest to participate in this rally. Far from it. This is telling us that, unlike the public, the Smart-Money is bearish.
Smart-Money indicator numbr 2 is another options ratio but this one is based on S&P 100 Index Options. There’s a very strong feeling that these options are mainly traded by the smart-money. So, unlike the ISE options ratio I showed earlier, this ratio is not a contrarian indicator but a confirming indicator. Once again I’m showing a 10day moving average of Calls; this time as a percentage of total options volume.
So what’s happening? Well, unlike the ISE sentiment index, as the market has been rallying this indicator is heading lower. Once again that’s a bearish Smart-Money indication.
If I show you those two option ratios together, one representing public sentiment and the other representing smart-money sentiment, you can clearly see the difference between their behaviour.
Okay I’m going to conclude by summarising the case for the extreme bear like this:
1 My price distribution analysis suggests that the March low is not the ultimate low for this bear market.
2 The most reliable time cycle I know of indicates another leg down pretty soon.
3 The Smart Money is not bullish.
4 The Not-So-Smart-Money is very bullish.
To me, in total, that paints a very bad picture indeed.
And there’s a couple more things.
Firstly, a level. 870 is a very important level on the SP500 index. I believe that if this rally can hold above that level for the next few weeks then I am probably wrong in this analysis but I don’t think that’s going to happen. But, and I think this is most likely, if the SP500 falls below that level a very fast move down will probably follow.
And lastly this. If the index does find itself below that level, below 870, and heading lower, I’m going to be listening out for the majority of market commentators to be calling the decline “a correction”, or “the expected test”, or “a great buying opportunity”, they might even say “this is the right shoulder of an inverse head and shoulders pattern”. In other words, as the market falls, I am expecting that bullish sentiment will stay high. That kind of comment will fuel the decline further.
This is a transcript of the audio content of the video Market Meltdown 2009. Original content by Bob Debnam.