Yesterday I was bombarded with a flurry of e-mails asking my opinion of the following commentary from Bernie Schaeffer:
"Much has been made by those with a bearish slant of the recent all-time lows in the Nasdaq-100 Trust Volatility Index (QQV). The bears argue that this low QQV is an indication of excessive bullish sentiment, also known as "complacency." And when investors become complacent, the market becomes vulnerable to a major decline.
But before you accept this bearish argument, I encourage you to examine ... the ebb and flow of the six-week historical volatility of the Nasdaq-100 Trust (QQQ)...this six-week historical volatility reached an all-time low in mid-March 2003. Why should you care? Because far too much is made of the QQV (and the VIX for that matter) as indicators of investor sentiment, or "fear gauges." The vast majority of the time, the QQV -- a measure of market expectations for future volatility -- simply mimics the recent trends in historical volatility, since the recent past is often the best predictor of the future. So if you're concluding that the low QQV is forecasting a decline in the market, what you're really concluding is that the market will weaken because volatility is low (a rather tenuous argument), rather than because investors are too bullish."
I'm only addressing this commentary because so many people are asking me to. Really, it's just another example of the commentary that is always seen at tops accompanied by extremes of bullish sentiment.
There's no need to argue with this, actually. I would just politely request to Mr. Schaeffer --or anybody interested in his argument -- to go back and actually look at what low historical volatility has meant for future price movement throughout the bear market.
Saying that the VXN is merely reflecting the low historical volatility is actually accurate, to a degree; but concluding that therefore it doesn't matter is just another instance of bullish hand-waving.
Speaking of fever pitch, there's a sentiment model that I want to bring to your attention from Jason Goepfert of SentimenTrader. One of the reasons I was excited to bring Jason's excellent analysis into our service is I wanted to occasionally "borrow" his unique and comprehensive sentiment measurements.
Jason's "Composite Model" is his amalgamation of the most valuable sentiment measurements. In this one model, he's blending the volatility indices, put/call ratios, commitment of traders, breadth, TRIN, etc, to come up with one comprehensive composite sentiment model. Here's how it currently looks:
This sentiment model has only dropped this low before the major market meltdowns. You can see it happened in May 2001, before the swoon into the September bottom; and again in March 2002, just prior to the epic 4-month drop into the July 2002 bottom.
This is just one more confirmation that the market is presenting a big-time opportunity to take the opposite side of the crowd and go short. It's actually extremes of sentiment like this that test whether you are a true contrarian. Lots of people say they are contrarians -- everybody does, actually -- but it's just not true. At extremes of sentiment, the mob thinking becomes irresistible.
Indeed, it's my feeling that there's something atavistic within all of us that makes us want to be part of the crowd. It's in our DNA. We want to belong. But in the markets, this is a very dangerous compulsion.
The only thing still lacking is the "spark of fear", and we'll just continue to patiently wait for something to come along to spook the vast bullish majority. Once the fear hits, it should proliferate quickly among the bullish majority.
I also want to answer another query that has been coming up frequently. I got an eloquently phrased version of this yesterday:
"I remember a few months ago when things were looking darker (and the market lower), you argued about the seasonality, the presidential election cycle, and even Arthur Laffer's positive market outlook for the coming year as a reason for stocks to go up. Apart from the seasonality question, what has changed your mind about the other potentially positive factors? Has the market seen the best the presidential cycle has to offer in its slow grind higher?"
I was indeed making this argument ahead of last October's bottom. Back then I was arguing strongly that the market had a real chance to bust wide open to the upside. Fear was reaching peak levels, and the set-up was really juicy for a sustained upside move -- even a new bull cycle.
By the way, I remember very clearly how I was one of the "lone bulls" back then, and I was bombarded with e-mails castigating me for it. Just as now I'm attracting attention for my bearishness. This always happens in the vicinity of major turning points.
The fact is the market never followed through on that beautiful set-up. Sentiment got too bullish, and too many believed. December's month-long slide pretty much erased any hope for that very bullish scenario. The market has flopped around since then, and not made any significant progress. Overall, it's potentially very bearish that this latest positive seasonal period has merely consisted of the market not going down to new lows.
As far as the third-year of a Presidential term, it's worth noting that the only times since 1914 when this third-year big rally didn't work out was twice during the 1930's.
One last note: Love 'em or hate 'em, the always provocative Debka drops another bombshell in this week's intelligence report. Debka is reporting that Saddam and his two sons are alive and well and hiding out in Belarus, under the protection of President Aleksandr Lukashenko, and with the full knowledge of Russian President Vladimir Putin. Debka also reports that Saddam has his loot of money and WMD still at his disposal. You can find all the details and much more about Saddam in Debka's report, available on our web site this morning.
Sentiment Dashboard
by Adam Oliensis
SENTIMENT TANK: The tank drained 1 point to 7% full of negative sentiment on Thursday. If your SUV has a 20-gallon tank and it's 7% full there's 1.4 gallons in the tank. The GAUGE light is ON. .If we don't find a filling station soon we're gonna end up having to call a tow truck.
SHORT-TERM: The hourly gauge is essentially neutral, with a very slight advance-phase bias.
MID-TERM: The mid-term gauge is unchanged at 100% in its very very very mature advance phase. Our Confidence Diffusion Index remains at 6 of a possible 7. It's possible that we could squeeze just a little more toothpaste out of this tube, if, say the VIX were to break to a new multi-year low, but to do that we'd probably have to really wrestle with the crinkled, gnarled tube and we'd end up hurting our thumbs.
LONG-TERM: The weekly gauge remains unchanged at 81% in its advance phase with a weekly CDI (also unchanged at 5.
BOTTOM LINE: Price began to show some signs of some weakness today, if only slightly. Our benchmark indices closed down...but so did the VIX. The bearish divergence is not just a matter of "traction" or "degree" but has now become so overt as to have the VIX actually moving wrong DIRECTION!
The Put/Call Ratios have been high, which can keep the market from dropping. However the combination of high Put/Call Ratios and the dropping VIX suggests that the puts are being purchased by smarter rather than dumber money. The people buying the puts are smart shoppers. They're buying a lot of them without driving the price up. Historically these smart shoppers tend to make money by buying cheap and selling dear. Those puts will get dear if the market goes down.
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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