SENTIMENT JOURNAL: Some Bears Jump Ship

Market Internals: The technical action of the market was much more constructive during the latest week of trading. The Dow Jones Industrial Average () rose during three of five trading sessions and added 300 points on the week. Meanwhile, the tape was strong. On the New York Stock Exchange, advancing issues beat declining issues during all five trading sessions. Up volume topped down volume four times. Finally, the NYSE New High New Low Index, which plummeted to -1,125 last Thursday, finished the week sitting near unchanged (with 26 stocks setting new 52-week highs and 27 falling to new 52-week lows.) The table above provides a summary of this week’s technical action on both the Big Board and the NASDAQ Stock Market.

Sentiment Indicators: Prior to this week’s rally, bearish sentiment had reached an extreme. One clear sign was the spike in the CBOE Volatility Index (). The market’s “fear gauge” closed above 30 last Wednesday and Thursday for the first time since March 2003.  The extreme readings from the VIX was a sign that premiums on the S&P 500 Index () rose to their highest levels in years, as nervous investors scrambled to buy portfolio protection.

Signs of excess bearishness surfaced elsewhere in the options market.  Traders were leaning heavily on the bearish side of the trade late last week and put volume surged. To be specific, on Thursday, more than 13 million puts traded across the six US options exchanges. That, in turn, was a new record. Figure 1 shows the recent spike in put volume.

 
Figure 1: Total Daily Put Volume

The widely watched Investors Intelligence survey saw a big shift prior to this week’s rally. The poll is conducted by surveying approximately 120 newsletter writers. In the latest period, the bearish percent rose for the fourth consecutive week to 37.4% and its highest levels since March 2003. Bullishness fell to 40.6% and the lowest levels in a year.

In conclusion, extreme levels of bearishness and negativity set the table for this week’s market advance. Now, as trading has become less volatile and the technical action of the market is improving, some of the bears are jumping into the bull camp and the rally is beginning to feed on itself. This pattern is constructive and can continue in the weeks or months to come. Importantly, however, there was one missing element during this week’s advance—i.e. volume. On Friday, less than 1.2 billion shares traded on the NYSE. By way of comparison, almost 3 billion traded on Thursday of last week. The lack of volume is due to the seasonally slow period during the month of August when many players are on holiday. A more convincing sign will be if stocks can continue to perform well when traders return because, in the words of the famous market technician Joseph Granville, “volume is the engine that makes the market train go choochoo.”  (Well, something like that.)

Frederic Ruffy
Senior Writer & Index Strategist
Optionetics.com ~ Your Options Education Site
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