07/05/2010 – What Do These 8 Technical Indicators Mean for the Markets?

Technical Indicators

It is rare to have technical indicators all lined up on one side of the ledger.
They were lined up this way—on the bullish side—in late February-early
March of 2009. Today they are just as aligned but on the bearish side. Consider
this short list:

1. The latest report shows only 3.5% cash on average in mutual
   funds. This figure matches the all-time low, which occurred
   in July 2007, the month when the Dow Industrials-plus-Transports
   combination made its all-time high. But wait. The latest report
   pertains only through February. In March, the market rose virtually
   every day, so there is little doubt that the percentage of
   cash in mutual funds is now at an all-time low, lower
   than in 2000, lower than in 2007! We will know for sure when
   the next report comes out in early May. Regardless, the confidence
   that mutual fund managers and investors express today for a
   continuation of the uptrend rivals their optimism of 2000 and
   2007, times of the two most extreme expressions of stock-market
   optimism ever.

2. The 10-day moving average of the CBOE Equity Put/Call Ratio
   has fallen to 0.45, which means that the volume of trading
   in calls has been more than twice that in puts. So, investors
   are interested primarily in betting on further rising prices,
   not falling prices, and that’s bearish. The current reading
   is less than half the level it was thirteen months ago and
   its lowest level since the all-time peak of stock market optimism
   from January 1999 to September 2000, the month that the NYSE
   Composite Index made its orthodox top. The 30-day average stands
   at 0.50, the lowest reading since October 2000. It took years of
   relentless rise following the 1987 crash for investors to get
   that bullish. This time, it’s taken only 13 months.

3. The VIX, a measure of volatility based on options premiums,
   has been sitting at its lowest level since May 2008, when wave
   (2) of ((1)) peaked out and led to a Dow loss of 50% over the
   next ten months. Low premiums indicate complacency among options
   writers. The quants who designed the trading systems that blew
   up in 2008 generally assumed that low volatility meant that
   the market was safe, so at such times they would advise hedge
   funds to raise their leverage multiples. But low volatility
   is actually the opposite, a warning that things are about to
   change. The fact that the options market gets things backward
   is a boon to speculators. Whenever options writers are selling
   options cheap, the market is likely to move in a big way. Combined
   with the readings on the Equity Put/Call Ratio, puts right
   now are a bargain.

4. In October 2008 at the bottom of wave 3 of (3) of ((1)),
   the Investors Intelligence poll of advisors (which has categories
   of bullish, bearish and neutral), reported that more than half
   of advisors were bearish. In December 2009, it reported only
   15.6% bears. This reading was the lowest percentage since April
   1987, 23 years ago! As happens going into every market top,
   the ratio has moderated a bit, to 18.9% bears. In 1987, the
   market also rallied four months past the extreme in advisor
   sentiment. Then it crashed. The bull/bear ratio in October
   2008 was 0.4. In the past five months, it has been as high
   as 3.4.

5. The Daily Sentiment Index, a poll conducted by Trade-Futures.com,
   reports the percentage of traders who are bullish on the S&P.
   The reading has been registering highs in the 86-92% range
   ever since last September. Prior to recent months, the last
   time the DSI saw even a single day’s reading at 90% was
   June 2007. At the March 2009 bottom, only 2% of traders were
   bullish, so today’s readings make quite a contrast in
   a short period of time.

6. The Dow’s dividend yield is 2.5%. The only market tops
   of the past century at which this figure was lower are those
   of 2000 and 2007, when it was 1.4% and 2.1%, respectively.
   At the 1929 high, it was 2.9%.

7. The price/earnings ratio, using four-quarter trailing real
   earnings, has improved tremendously, from 122 to 23. But 23
   is in the area of the peak levels of P/E throughout
   the 20th century. Ratios of 6 or 7 occurred at major stock
   market bottoms during that time. P/E was infinite during the
   final quarter of 2008, when E was negative. We will see quite
   a few quarters of infinite P/E from 2010 to 2017.

8. The Trading Index (TRIN) is a measure of how much volume
   it takes to move rising stocks vs. falling stocks on the NYSE.
   The 30-day moving average of daily closing TRIN readings has
   been sitting at 0.90, the lowest level since June 2007. This
   means that it has taken a lot of volume to make rising stocks
   go up vs. making falling stocks go down over the past 30-plus
   trading days. It means that buyers of rising stocks are expending
   more money to get the same result that sellers of declining
   stocks are getting. Usually long periods of low TRIN exhaust
   buying power.