I am of the opinion that failures usually provide more important signals than confirmations. For instance, if a company reports good news and sells off, then that action speaks louder than if the stock had bounced on the news (not withstanding all the “buy on the rumor, sell on the news” lore.) The same is true for broad market data and the broader indices. To my mind, these are fundamental failures. There is an analogous situation with technical analysis. A failure in this context could be a stock or index that has consistently bounced off of a particular support level that now violates that support and continues lower. I believe that these TA failures speak volumes more in terms of informational content than if support had held for the n+1th time.
Which brings us to yesterday. Two measures in particular suggested that market sentiment was so strongly negative as to make a bounce a high probability event: the ISEE had just hit a new low in its 20 day SMA and the NASDAQ TRIN (30 day EMA) had spiked to levels not seen since 2002. The bottom line is that it a bounce should have been like shooting fish in a barrel for the bulls. Since the bulls could neither hold onto their gains, nor put a dent in the selloff that ensued, I am forced to conclude that in the course of this substantial sentiment failure, they didn’t even graze any of the fish. I am also changing my bias to bearish until the bulls can demonstrate a modicum of marksmanship…
Bill,
ReplyDeleteI think that sentiment "failure" showed itself at the top and then was confirmed at the first low. The 2CS, which I defined as the five day running total of daily VXO and the CBOE combined P/C, had been giving multiple deliriously bullish readings (<50) in February 2007 and once only in April as the indices resumed their climb out of the March lows. But as the market marched up to July, the 2CS began to rise. It was nearly 70 at the July high. This was a major change of sentiment character. This was a reversion to 2CS range extremes seen at rally highs during the bear market to 2003.
I mentioned my monitor label, "sentiment divergence happens", but that is a short term happening. When divergences are as great as that from February to the July highs, there is definite range shifting going on, and that means that the markets are "in the process of" making a longer term top.
From the July highs to the end of July the 2CS was already nearly 150, not seen since the first half of 2003. This was the confirmation of probable longer term trend change. The delirious bullish high range had shifted but also the rather placid low range had now become somewhat delirious. Bearish delirium reached 198 on July 17.
By then it was evident that a broadening distribution top, called different things by different people--reverse point waves, expanding triangle, etc.--was also forming in many indices. Since distribution in a top takes a long time, it was reasonable that it should last longer that three months from May to August.
On the rally to October new highs 2CS only got as low as 63. No more delirious 50's or 40's as in 2006 and up to February 2007. 63 is almost exactly the number attained on the rally into May 2002 and on other bear market rally tops. The top was in.
Personally I did not run out that day and shout in the streets or liquidate everything and load up on puts. I had been trimming into strength all year.
Sentiment does diverge and it exhibits range-shifting longer term, as it also did in 2002/2003 at the lows. To grasp it requires a mental shift from the notion that the majority is always wrong at the wrong times, as you clearly see. Range shifting is the sentiment equivalent of Dow Theory price waves. I think it's even better.
Tom
Lots of good stuff to chew on here, Tom. Thanks for sharing some of your thinking.
ReplyDeleteCheers,
-Bill
For those who may be interested, Tom has converted his comments here into a post on his own site, with some accompanying charts that help to tell the story: Sentiment Failure in 2007
ReplyDeleteFWIW, I find the graphics to be very compelling and I encourage readers to click through to Tom's site to get a better sense of his thinking across a broad range of market-related subjects.
The sentiment is a contrary indicator
ReplyDeletewhich works only at extremes. The sentiment indicators do not show the strength of bulls and bears. So if everybody is bearish and is short or in cash the downtrend will stop. However, it does not mean that the will be a sharp reversal. Bulls need to overcome fear to jump in. So we may see a short term rally on the first good news.
Interesting day today...
ReplyDeleteI fear I'm more sanguine about the market than you, Bill, despite the very compelling case you present.
Towards the end of the trading session, I thought we might have a 'doji' day on big volume, indicating indecision, and a possible reversal tomorrow. But the bulls gained the upper hand by the close, despite a negative report about January retail sales.
But even as the market was falling from the highs set earlier in the day, the VIX remained stubbornly in the red... which suggests to me that fear is dissipating somewhat (because I often observe the VIX rise above the previous day's close during an intra-day selloff).
And, it's possible that the retail sales numbers were trumped by the decline in jobless claims. That number seems to contradict the ISM service sector number which precipitated this week's bearish action.
But what do I know?... I've had a brutal week, and perhaps I'm overeager for a bullish run on expiration week.