Tuesday's upside price reversal marked the firm significant time in more than a month
that the market seemed to take bad economic news and actually shrug it off. The big
drop in Consumer Confidence to the lowest level in a decade initially was given as a
reqason for the early morning decline, but the late-day upside reversal into positive
territory was a major plus.
Investors always ask me "How can the market rally when there is so much bad news (or
potential bad news) out there?" Clearly, when a market gains ground in the face of
such negativity, this is a signal that investors have already discounted that
pessimistic scenario by selling shares in front of the news.
One such indicator is the American Association of Individual Investors (AAII) poll,
which we relied on to get bullish signals of significant bear-market rallies in
mid-July and early-October last year. Currently, the AAII Bears have again just
reached very high proportions, with 57.9% Bearish according to the past week's
survey. With this bearishness at high levels, upside reversals like we saw Tuesday
on "bad" news from the low Consumer Confidence figures suggest that in the short
term, the market wants to rally. In the long term I'm still not convinced that this
will be more than a bear market rally of roughly 6 weeks or so. However, the last
two times we saw readings over 55% Bears in the AAII poll were in mid-July and
mid-October 2002, right ahead of sharp rallies. A number of other sentiment
indicators are not as clear here as they were at those 2002 bottoms, with both the
VIX and the put/call ratio not in the extreme fear zone. Meanwhile, the RYDEX ratio
shows a big jump in fear over the last five weeks. This pessimism has me wanting to
lighten up our short positions and get ready to look for new bullish positions over
the next week.
S&P 500 & AAII BEARISH (RED) AND BULLISH (GREEN) PERCENTAGE
When the bearish percentage line (in red) is greater than 50, or twice that of the
bullish percentage value (in green), that usually signals a market bottom. Current
bearish readings are well over 50, and easily twice that of bullishness.
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