Calling the market in the near term right now is a little tough, given a couple of negative developments that occurred on the charts from last week’s market meltdown. Over the summer, I had been calling for a correction into the technical support area of 1250 or so for the S&P500. On Wednesday of last week, we had a nice intra-day reversal off of about 1243 to end with a close over 1250 on the day. I placed some (not all ) of the cash I have been hoarding over the summer into the markets that day–with a focus on U.S. equity. For less than 24 hours, I felt pretty smug about that move. Then came Thursday and Friday.
The S&P broke 1250 with a vengeance. Some technicians have pointed to what they feel is a head and shoulders top on that index, although I’m not so sure I agree with that prognosis. If they are correct in that formation, a measured move target would bring the S&P back to 1150 or so. Either way, a break of the support level that has held for the better part of 2011 is not good news. And of course, let’s not even talk about the break of the 200-day MA (yeech!).
However, there is a little bit of shining light at the end of the tunnel. Sentiment indicators have moved smartly into “buy” territory. The study of sentiment indicators is kind of a hybrid form of technical analysis. One must decide when to marry the two, or when to place more emphasis on the observation of chart patterns (technical) vs. sentiment indicators. The current situation brings me back to the environment of early 2009 when markets were plummeting through all levels of technical support, including the old 2002 lows. Dire predictions of Dow 1000 and S&P 100 were emerging. But the sentiment indicators were telling a different story. They were getting bullish.
So, here are just a few (there are many, many more) sentiment indicator observations that you could take into consideration when trying to determine just how far this market may have left to fall:
- The VIX “fear gauge’ shot up late last week to a one-year high. Gason Goepfert of sentimentrader.com notes that the last 2 times this happened the markets were 8% and 16% higher respectively in the following 3 months.
- The ISEE call/put ratio has dipped at or below the 80 level 3 times last week (once intra-day)–again a sign of capitulation and oversold conditions. I conducted a study on this indicator when combined with oversold momentum indicators such as RSI and this can be an accurate turnaround signal.
- Speaking of RSI–its not a sentiment indicator, but went pretty deeply oversold (well into the low-20’s) during last weeks crisis. As mentioned above, when combined with a low ISEE level–its a pretty good indicator of a turnaround pending.
- Lastly- I have borrowed a chart from sentimentrader.com. below showing the American Association of Individual Investors (AAII) survey of % bulls. Basically, sentimentrader’s work shows that when this survey shows less than 35% bulls, bullish reversals occur shortly thereafter. See the chart below, where they’ve marked these vital points.
So there you have it. A lousy technical environment but a bullish sentiment and oversold oscillator environment. Choose your team. I’m inclined to go with the sentiment indicators – I’ve rarely seen them steer me wrong.