Heat rising in bear camp, TecDAX traders are in agreement
The two-day selling frenzy from last week is history. Both prices and the confidence level among investors have increased significantly since the start of this week. Concerns about the euros being too strong and the markets being overvalued were not able to take hold. Investors are now talking about signs of an imminent year-end rally.
DAX Sentiment
October 29, 2003: “Thumbs down” for German shares was the mantra of some short-term oriented traders shortly after the last Sentiment survey. As a result, this attitude catalyzed a sell-off that knocked 4 percent off the DAX within 48 hours. Prices have been able to recover, however, since the beginning of the week. The advance was even faster than the preceding retreat. This scenario fits almost exactly with the mood that has been characterized in the media over the past five days. At the end of last week, there were still fears that the gains from the recent past were not justified given corporate profit forecasts. Developments on the currency market regarding the euro were also a hot topic among skeptics. Some strategists even offered up the concern that the market was overvalued, that the rally during the past six months might even contain signs that a new bubble was forming. The pessimists’ voice grew significantly softer, however, at the start of this week. The strong counter-reaction that catapulted the DAX upward by 6 percent was simply too much of a good thing for many bears. In the meantime, the latest gains are being interpreted as signs of an imminent year-end rally. And once again, the statisticians are back at work. These are the same ones whose forecasts for the exchange’s “traditionally weak months of September and October” are all too fresh in our memories. Investors can only express astonishment, because again there is talk of a seasonal effect, one that has been observed during the past 30 years. The argument says that during this time of year, the market phase from November to January has been disproportionately strong. And all of a sudden, year-end forecasts have the DAX trading at closer to 4,000 points than to 3,500.
Sentiment Indicator
The blue bars in the diagram represent the amount of optimism in the market. To calculate this, the number of optimists are compared to the number of pessimists and weighted against the number of neutral votes. However, the absolute values of the figures are not relevant for analysts, but rather how they changed in the course of the period surveyed.
In light of this background, one can justifiably assume that the majority of short-term market participants’ positions are on falling prices – or at best on a sideward-moving market. It is safe to say that no one expected gains to the extent that they were registered in the past three days. The reporting season is going better than expected. The element of surprise that accompanied the latest gains cannot be missed. It is no great wonder, then, that our regularly surveyed institutional investors also had a change of mood. Now, none of these respondents wants to miss a possible year-end rally; a week ago their camp registered a decline in optimism. Measured by the Bull/Bear Index, the level of optimism rose to a high for the year, its highest level since the middle of December 2002. The bear camp rose by a full 17 percent. In contrast, only a quarter of those surveyed are betting on lower prices. Things are getting uncomfortably hot in the bear kitchen.
Even if one assumes that traders had good timing and changed tact at relatively attractive prices, one thing becomes clear very quickly: A majority of the bullish ammunition has already been expended. The high level of optimism is not alarming in and of itself, but it should be a sign for caution. For it is exactly at times such as this, when a large majority of traders expect a new high for the year, that the danger that a double top will form is at its greatest – especially because no one is talking about it at this time. Moreover, if prices were to decline, one can no longer assume that there is a great propensity to engage in added new long positions to already existing ones. In order to achieve its new high for the year, the DAX did not necessarily exhaust the latest gain in market sentiment; perhaps it can ride it to gain another 1 percent. But the air will get increasingly thinner and there certainly will be a lack of demand if larger declines were to occur.
Ratio of optimists to pessimists
Bullish Bearish Neutral
Total
62 %
22 %
16 %
Like the DAX, the TecDAX also experienced a yo-yo effect, but the technology index’s ride was much more spectacular. It fell by 6 percent before reversing course and shooting up by nearly 11 percent. These strong price fluctuations led to market participants’ being in almost unanimous agreement on one thing: volatility will remain high. Still, a clear opinion about the future development of the German technology index has meanwhile taken hold. The majority expects prices to rise. Our Bull/Bear Index shot up to its second-highest level since it was introduced. Almost a third of the TecDAX bears evacuated that camp, which sunk to the anemic level of 21 percent. In contrast, nearly two-thirds of the surveyed traders agree that the index will continue to advance.
Last week’s decline was too deep for us to stick to our target level. Nevertheless, the TecDAX still has a chance of posting a new high for the year, despite the relatively high level of optimism. One can question, however, whether there will be enough strength to break through the 600-point level with only a fifth of traders in the bear camp – especially since trader profits are seldom refused, and one must expect that they will be taken down if prices rise further (most likely around the 585/590 level). Just as with the DAX, the idea that tolerance for falling prices will not be very high also applies to the TecDAX. Therefore, given the current high level of optimism, one must dispense with prevailing caution: Prices that go below 520 points should be seen as a warning sign.
TecDAX: Ratio optimists to pessimists
Bullish Bearish Neutral Total
Private
64 %
21 %
15 %
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