The Teflon Market
The Shanghai stock market drops over 8% in one day, interest rates are on the rise and the price of gasoline surpasses highs not seen since the late seventies And yet, the Dow Industrials continue posting new highs day in and day out. The Benchmark S&P 500 and Russell 2000 also joined the celebration this week closing at all-time highs.
The resiliency of this market is enough to put the bears into permanent hibernation. Of course this isn't going to happen, but this certainly does underscore the unrelenting flow of capital serving to underpin this advance.
The stock market loves to confound the majority and this is why sometimes it pays to be a contrarian. You might think that after such a protracted advance, the investing public would be wildly bullish. Surprisingly, this is not the case. In actuality, it's quite the contrary. By most sentiment measures, a large number of investors are either sidelined or outright bears. Sentiment measures such as "The American Association of Individual Investors Survey", otherwise known on the street as the AAII, and the ISE Options Sentiment Index, bear out this notion (no pun intended).
The AAII does a monthly poll in which it asks its members if they are bullish or bearish going out six months. In the latest survey: 33% of the respondents were bulls and 45% bears. This is quite revealing in light of the duration and magnitude of this rally. In the current environment of rising stock prices, the surplus of bears augurs well for a continuation of the rally.
The ISE Put/Call ratio (which happens to be my favorite sentiment gauge) is also signaling investor pessimism. The most recent readings have been in the low 100 range and the 50 day moving average of this gauge closed at 125 as of the day of this writing.
To better understand this indicator and how it works, here's a brief explanation: The ISEE is a composite of equity option transactions (no index options are used). The transactions are compiled by dividing long call (opening positions) by long put (opening positions) and multiplying them by one hundred. To put this in simple terms: if the preponderance of options being purchased are calls (a bullish bet), then market participants are very optimistic. Conversely, if volume is largely skewed towards put purchases (a bearish bet), then this is an indication of anxiety among investors. The ISEE index, as is the case with most technical indicators, is most useful as a trading tool when it exhibits extreme readings. In this case, readings under 100 are Bullish and over 200 bearish. Historically, when small option speculators have moved "en masse" to one side of the market, they have been uncannily accurate at marking major turning points.
Let's now turn our attention to this week's ER2 (E-mini Russell 2000) charts. After the false break out, (chronicled in last week's newsletter) the ER2 regained its footing and quickly retraced the two-day correction. This set the stage for the subsequent push to an all-time close on Friday and Monday. (See Chart Below)
In observing the hourly chart of the ER2 below, we see the 38.20% retracement level which coincided with last week's lows provided support for Tuesday's intraday sell-off. This illustrates the use of Fibonacci retracement in smaller time frames and how they can be useful in determining support levels.
In summary: This week the market is fixated on bond yields, particularly the 10 year note and specifically the 5% handle. This caused some initial jitters Tuesday morning, but as we pointed out in the charts, there was a late day recovery. The lack of economic data this week leaves us with very few catalysts. Traders will be left watching bond yields and the Chinese market for cues. The action for the past several days has been rather sloppy which may portend a pause or correction is in the offing in the near term. We'll just have to watch, wait and take action when it's appropriate.
So until next time, I hope everyone has a profitable week.
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Gabe Velazquez is a professional
trader with 14 years of experience. His focus is intra-day and swing trading the
ER2 (Russell 2000 e-mini) using technical analysis as his primary tool. Gabe has
managed both stocks and futures accounts as well as conducted educational seminars
on technical analysis for the past ten years. He is a frequent guest on Biz radio,
where he shares his market knowledge and utilization of technical indicators.
Gabe also teaches the