Lately I've been discussing the classic bear market sentiment patterns that are leading me to conclude this market has a big problem. A falling VIX together with falling prices is a highly distinctive bearish sentiment footprint.
Invariably at these moments, I get the same type of e-mails, and come across the same market commentary. The gist is this: "This time it's different. In bull markets the VIX can go into the teens, and stay there for months."
Since I'm getting these same types of letters now, I'm thinking we're within a week or two of a major top in the markets. This is how it's always worked.
People are quick to believe "this time it's different." It's just human nature. And it's one of the primary reasons why the VIX never seems to lose its power as a market timing tool. Only a tiny sub-set of market participants even know what the VIX is, and of that tiny sub-set only a small fraction have enough faith to trust it at important moments.
It's always best to keep it simple when analyzing the markets. Don't over think it. Don't perform convoluted analytical gymnastics to explain away things that have very obvious interpretations.
Sure, this time may indeed be different, and the VIX might go down to 12 while the Dow soars over 11,000.
But do you really think so?
This market is having a hard time even staying over the "home" level of SPX 876, much less make a run at higher ground. And all the while people get more bullish. I'm just not planning on over thinking that one.
Another confusing thing we've seen lately is a relatively high put/call ratio while the VIX has been dropping. Theoretically a high put/call ratio shows excess bearishness, while a declining VIX shows growing bullishness.
With such seeming anomalies, again, I don't try to over think it. I see this as another sign of growing optimism about the market. If the VIX is dropping, and there are a lot of puts changing hands, then that means that people are in a mood to sell puts , which is a highly bullish strategy.
Since this might be a little confusing, I'm going to back up and walk you through some details about the VIX and the way options trade.
The VIX is a measurement of the premiums paid for S&P 100 (OEX) options. It's a great proxy for the actual supply and demand in the markets, and gives an unparalleled insight into how traders feel about stocks.
Having traded thousands of OEX options in our service over the years, I've got lots of first-hand experience in how these contracts trade in the real world. In options trading, there are market makers, whose sole job is to make you pay more when you're buying, and give you less when you're selling. It is a ruthless game, played by extremely clever and experienced professionals. You never, ever get a break.
These market makers are absolute masters at pricing options based on supply and demand in the market. Whether you are buying or selling options, the market makers are always there to take the other side of the trade -- and always to their advantage.
When the VIX is rising, it means people are willing to pay higher premiums for puts and calls. There is demand on the buy side, and the market makers are only too happy to jack up the price of options into this surge in demand. Invariably, such buy-side demand comes when people are fearful of the market.
When the VIX is falling, it means options prices are coming down, and premiums are contracting. There is less actual demand in the market to buy puts and calls. Such a lack of demand is strongly associated with market participants feeling hopeful about the market.
Yet when the VIX is falling, and the put/call ratio is high -- as it is now -- then that strikes me as a very dangerous thing. It can only mean that people want to sell puts . Selling puts is a very bullish strategy, as you are collecting options premium under the notion that the underlying stock or index is not going to fall below your chosen level.
Remember, the market makers always make you buy high, and sell low. If the VIX is falling, and the put/call ratio is high, it means the market makers are selling low . That's not bullish, not by a long stretch.
Another thing which many are seeing as bullish is the recent surge in long positions by commercial traders in the big S&P 500 futures contract. Yet there are a few thorns in this rosy data point.
First off, the commercial traders in the e-mini S&P 500 contract are heavily net short. So that's a weird divergence. Also -- and more importantly -- commercial bond traders are net long. Since there is an inverse correlation between bonds and equities, this has bearish implications for stock prices. I should also point out that these bond commercials have a great track record.
Plus there's a downside to the commercial traders having a lot of long exposure. It means that rallies can be met with plenty of supply. I think we saw this last week, on three separate occasions, when opening gaps were met with a barrage of selling in the futures pits.
Could this be commercial traders paring back long positions? Absolutely. These traders sell into strength, and buy weakness. That's their game. This overhang of long exposure is not going to be a good thing if data points don't start coming in bullish.
There are just lots of confusing sentiment points right now. Some are bullish, and some are bearish. But the thing that I can't get past is that prices are failing to make upside progress while sentiment is growing more and more bullish and complacent.
This doesn't mean prices have to collapse right away. Tops are often rounded, drawn out affairs, with repeated attempts to push higher. We may get a few more of these yet.
But the next BIG move will be to the downside, and that's the one we'll want to really bet on when the time is right. That time is quickly approaching.
One last note: I noticed something strange and fascinating on the intraday chart off the recent March low. It's tracing out almost an exact mirror-image pattern.
One of my charting packages has a feature called "mirror-image foldback", which is shown below. If the pattern is going to continue to hold up, it doesn't look good for the markets. Obviously we can't put too much credence in such forecasts, but markets do show a tendency to act in symmetrical ways in terms of price and time.
Sentiment Dashboard
by Adam Oliensis
SENTIMENT TANK: The tank drained 3% on Friday to 25% full of negative sentiment. The last time the tank was at this low level the market was declining from a full-on test of major resistance in the mid 900s. We could spurt ahead to that level, but if we do, this market will drain its negative sentiment fuel down to fumes.
SHORT-TERM: The hourly gauge is in an advance phase.
MID-TERM: The mid-term gauge gave us a buy signal rising 4 points to 90% on Friday. However the Confidence Diffusion Index (CDI) is still at 0. The momentum of sentiment shows a marked increase in bullishness, but PRICE has not appreciated as the tank has drained. The increase in bullishness has not gotten any traction. That bearish divergence has made it hard for the CDI to confirm the buy signal.
LONG-TERM: The weekly gauge has given a buy signal with a weekly CDI of 3 (out of 7). This could turn into something interesting. However, as we've discussed lately, there's a high probability that the effort to create the weekly buy signal has drained the tank and exhausted the shorter-term measures of sentiment.
BOTTOM LINE: Any short-term rally up to or slightly through resistance is likely to exhaust the market's supply of negative sentiment. The market will likely have to refuel, scare its participants into more bearishness, and THEN it could be nice and ripe to confirm the weekly buy signal and walk up a wall of some worry.
Se não receio o erro é porque estou sempre pronto a corrigi-lo
There's no bull side and no bear side. JUST THE RIGHT SIDE!
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