When Will the Bears Retreat?
By Mark Arbeter
After some strength early last week, the major indexes fell to their lowest levels of the year, as institutions continue to dump shares. While price and volume measures have been abysmal, many sentiment indicators have moved to extreme oversold readings, increasing the probability that some type of rally is not far off. However, with trading volumes and interest in the market tailing off during the summer months, we continue to believe the final low of this brutal bear market will take place sometime in the third or fourth quarter.
Because of the weakened state of the market and the fact that we are in the EPS confessional season, it is likely that the S&P 500 will break below last Friday's lows of 981.72. The Nasdaq has already broken below last Friday's intraday low of 1445.40. This will set the stage for a test of the levels seen on Sept. 21. The closing low on Sept. 21, 2001, for the "500" was 965.80 and the intraday low was 944.75. The mid-900 level also represented the bottom in October, 1998. For the Nasdaq, September's closing low was 1423.19, with a print low of 1387.06. Remember, price tests on the Nasdaq frequently go below the initial low by 3% to 5%.
To put in a potential set-up for a major intermediate-term bottom, sentiment has to move to extreme levels of bearishness. The markets also have to get extremely oversold. While these two factors do not give you confirmation that a new rally has begun, there are critical ingredients to suggest that the worst is over. After a major low, there must be strong accumulation patterns by institutions over a two-week period to confirm a rally is in place.
During the past couple of weeks, all the sentiment indicators we follow have either moved to extreme oversold readings or are in the process of doing so. Short-term investment polls (Consensus and MarketVane) have been registering extremely low bullish levels for the past two months. Bullish sentiment on these two polls has moved to the lowest levels since last March and April.
CBOE put/call ratios have been extremely high of late, with six daily readings over 1.00 in the last month. The 30-day exponential moving average of the CBOE put/call has moved to 0.88, the highest since a 0.89 reading on Sept. 21. If the 30-day rises above 0.89, which is likely after Friday's high level, it will be the highest level since April, 1995, when it hit 0.92. The 10-day p/c ratio is also at the highest level since September. There has also been seven equity-only put/call ratios, including today's, of over 0.80 since June 6, equaling the seven readings this past September.
Investor's Intelligence poll of newsletter writers has shown decreasing levels of bulls and increasing levels of bears over the past three weeks. Bullish sentiment has fallen to 40.8%, from near 55% in April, the lowest level since last October. Bears have increased to 35.7%, from 28.4% in April, the highest since October. While this is a large improvement from a contrarian viewpoint, most bottoms are formed when there is at least a 40%/40% split between bulls and bears. During the bottom in September, 2001, bulls fell to 33.7% and bears rose to 42.7% and in the midst of the 1998 low, bulls were 36.2% and bears were 47.5%.
Looking back even further to December, 1994, when the overall sentiment towards the stock market was really poor, bullish sentiment on this poll was 31.6% and bearish sentiment soared to 59.1%. While it is impossible to say if sentiment has to get that bearish, it certainly would not hurt given the state of the market over the past couple of years.
While the market is most likely near a temporary bottom, the indexes could drift sideways like they did in 1994, before setting the final low late in the year.
Arbeter is chief technical analyst for Standard & Poor's