Expect retests

I was on BNN television on Tuesday of this week, and took the contrarian opinion (being my usual self!) of declaring that Monday’s lows were probably the lows for the current selloff. You can have fun watching me struggle on the video to keep my earpiece in place as I speak with host Michael Hainsworth. As readers of this blog know, not only did I call the top earlier this summer for the S&P 500, but I blogged last week stating that we were within spitting distance of seeing the bottom. My decision to call Monday’s lows as the bottom came from the following factors:

• A huge number of contrarian sentiment indicators moved into buy territory late last week and early this week. These include (but are not limited to) the ISEE call/put ratio has moved into buy territory, the AAII survey of investors has moved into buy territory, and the Rydex survey of funds have seen a rise in inverse ETF purchases to 4x that of long fund purchases.
• The VIX spiked to a 1-year high Monday (last time this high was May 2010) which is an indication of massive volatility—this level of volatility and fear historically doesn’t last (BTW—VIX is incorrectly called fear index—it can also spike in bull runs!)
• My favorite momentum indicator RSI hit a super-duper mega low point on Monday at 16!!!!!!!!! Combined with sentiment, this is an important turnaround signal. I wrote my CMT thesis on this—I proved that combining call/put ratio with RSI lows = very high probability of market bottoms.
• A study by sentimentrader.com showing that historically when you get a 6% drop in 1 day following at least a 4.5% drop the prior week, you get an average return of almost 15% over the following 6 months. Importantly, the returns are not only high on average, but this pattern has returned positive returns 11 of 13 times we’ve seen this since 1929—the last time being November 2008!
• Technically-the S&P has support at 1120 from a year ago—see chart below. Note how we are bouncing off of that level.

I would like to point out that there are few occurrences of bear market “V” reversals. Its highly likely that we will see another selloff and test of the S&P 1120 area again in the coming days or weeks. Having said that, it is my firm belief that as the market forms a base you and I will have ample opportunity to load up on equities we are bullish on.

On a final note: I would appreciate input on topics or sectors you would like to see covered over the months and years (no individual stocks, please!). Just add a comment to offer your suggestions for future analytical subjects. All the best!