Sentiment Showing Fear...

Jack Steiman from SwingTradeOnline.com at 02/11/10

A while back, when I spoke about the need for the market to move lower based on sentiment extremes, I warned that fear would kick in hard and fast and that it wouldn't take long before the bears start to ramp up thus bringing the sentiment issue to a close. In fact, it would likely lead to having too many bears. On January 13th of this year we had a spread of exactly 37.5% more bears than bulls. Over that critical 35% area that usually changes the trend over time. Because sentiment isn't an exact timing mechanism, it needs a catalyst to get going. There was no way to say just when the selling would kick in hard. It didn't take long at all. Now we look at the readings from February 8th and we see the bull bear spread is down to 8%. A 29.5% move the other way from where were just four weeks prior.

That is amazing to see, yet, I can't say I'm totally surprised. Because you all know by now that I believe fear rules over any other emotion known to man. I knew it would unwind rapidly, just not this rapidly to be honest. So here we are today. The market from top to bottom at its lows moved down just a hair under 10% on average when looking at the majority of important index charts. A correction. Now the question becomes, can this market move in to a strong bearish phase based on these new readings.

While anything and everything is possible in this market based on news unforeseen, I'd say the odds are well less than 10% of that tasking place. Bear markets do not start with bull bear spreads at 8%. With this weeks action thus far, it may be even lower than that now.
Why do I say that? Because today alone, on the early day selling, we saw put call readings well above 1.00. As high as 1.28, which shows levels of extreme pessimism among traders. This tells me with even more certainty that a bear market is quite unlikely.
Sentiment is huge in this game. They're game changers at extremes. While 8% is not extreme by any means, it's not a level from which a bear can usually begin. Sentiment says this will remain only a correction and not the start of a new bear market.

The recovery today off the early morning lows came to be when the put call I just spoke about started to soar early on. There are many times when you'll get a reading or two of intense complacency or pessimism but they ware off rapidly and thus you don't give it too much attention. Today, after the first two high readings in the low to mid 1.20 range, we saw a third and then fourth followed by a fifth reading as high as 1.28. That folks is pessimism. No denying it. This is why the rest of the day was spent moving higher off those lows early on when the Dow was down just under one hundred points and with the Nasdaq showing losses of nearly 1% or 20 points. You just can't stay down there with readings on the put call so high.

The financial's were strong all day and by now we know that this lagging sector has to get moving skyward if the bulls have any chance of claiming back those lost 20- and 50-day exponential moving averages. While today saw solid action there, it's just a start and needs to start showing the ability to follow through for multiple days in a row. That has not really been the case lately so we'll need to see a change in the current pattern but high readings of bearish sentiment over a longer period of time can get that job done for the bulls.

Without the financial stocks getting involved I find it hard to imagine this market having any sustained upside over the short and medium term. Good action there today but this sector is well below critical resistance so you can't start playing these stocks until we see more consistent action or more importantly, we start to see some solid divergences on the MACD and other oscillators on the daily charts. A nice start today but nowhere near what's needed quite yet.

We're still in down channels on the major index charts as seen on the third and fourth charts this evening. The Diamond (DIA) and S&P 500 Depository Receipts (SPY) show these down trend channels quite clearly and it tells us that extreme caution is warranted here.
With RSI's in the upper 30's on the index charts, you don't want to get aggressively short but you also don't want to start buying at this juncture.

Cash is the message based on these down trending charts. So yes, sentiment has improved dramatically but it doesn't mean we're just going to blast off. Not by any means and with the charts looking as they do, you have to go so boringly slow here whether you like it or not. To go against this would likely mean a hard time on the financial front. These markets take out both bulls and bears alike. We need to understand critical levels of support and resistance if you're going to play or even if you're not.

Resistance is at the down trend line or 1080 on the S&P 500. Above that, and only ten points away, we have gap at 1090 and then just above that we have the 20-day exponential moving average at 1091 and the 50-day exponential moving average at 1099. Extremely tough job for the bulls on any attempt higher. A strong confluence of resistance between 1080 and 1099. The Nasdaq has gap resistance at 2178. Above that we have the 20- and 50-day exponential moving averages at 2192 and 2204 respectively. Also a tough job ahead for the bulls between 2178/2204.

Bottom line is sentiment is now more favorable but will need a catalyst over time. This market is full of trouble short-term and only when strong divergences show up, preferably on the daily charts, can we think about aggressively going long. Cash is truly the best play right now folks.