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Capitulation of Bulls Bodes Well for S&P 500: Technical Analysis

Individual investors and newsletter writers are the most bearish on U.S. stocks since at least August, a sign the six-week slump may be nearing an end, according to analysts who use charts to predict markets.

The 7.2 percent drop in the Standard & Poor’s 500 Index since its April high through yesterday has turned more investors pessimistic as economic reports stoked concern the economy is slowing. A survey from the American Association of Individual Investors showed bears outnumbering bulls by the biggest margin since August. The ratio of bullish-to-bearish publications in Investors Intelligence’s survey was the lowest since September.

“We have some fear in the market,” Katie Stockton, MKM Partners’ chief market technician, said in an interview from Greenwich, Connecticut. “It’s a good thing from a contrarian perspective in that a market low typically is established when there is fear in the market.”

More pessimism suggests shares are likely to rise because bearish investors may have sold their holdings and would have to buy to get back in. The S&P 500 posted its longest losing weekly streak since 2008 as reports on jobs and manufacturing missed economists’ estimates and Federal Reserve Chairman Ben S. Bernanke said the U.S. recovery was “frustratingly slow.”

The AAII’s weekly survey showed 43 percent of the respondents were pessimistic, the ninth consecutive week that bearish sentiment stayed above its historic average of 30 percent. Bulls accounted for 29 percent, down from a peak of 63 percent on Dec. 23. The ratio of bears to bulls was 1.47, the second-highest reading since Aug. 26 after last week’s 1.95. The last time bears outnumbered bulls by a wider margin, the S&P 500 rallied in five of the seven following months.

Bearish Writers

Bears also grew among newsletter writers. The proportion of bears in Investors Intelligence’s latest weekly survey rose to 26 percent, the highest since October, from 23 percent. Optimistic newsletters amounted to 37 percent, down from 41 percent. The ratio of bullish-to-bearish publications of 1.42-to-1 was the lowest since September.

The options market also showed signs of rising pessimism. The ratio of puts to calls on U.S. equities rose to 1.11 yesterday, the highest since November 2008, Bloomberg data show.

Christopher Verrone, head of technical analysis at New York-based Strategas Research Partners, said that before last week, there had been 11 other occasions when the put/call ratio exceeded 1 and at the same time the S&P 500 was trading above a rising 200-day moving average. In all the circumstances, the market posted gains in the next 12 months, with returns averaging 11 percent. Calls convey the right, without the obligation, to buy a security at a set price by a given date, while puts give investors the right to sell.

Rally Tempered

The S&P 500’s slump since the end of April cost the benchmark index the biggest rally in more than five decades. The measure gained 102 percent between March 9, 2009, and April 29 of this year, the largest advance over the same period of time since 1955, according to Howard Silverblatt at S&P. Through last week, it was up 88 percent, the most since 1999.

Stockton said she expects the S&P 500 to fall below 1,250, a level close to the benchmark’s 2011 low and its 200-day moving average of 1,256.80, before resuming its advance.

“You get a move below it, it spooks a lot of people and you get even greater spikes in the sentiment data, and that’s when we get a real low,” Stockton said.

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