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Brad Lamensdorf, the founder and portfolio manager of Active Alts, is a principal and co-manager of the AdvisorShares Ranger Equity Bear ETF. He previously managed a long-short investment partnership from 1998-2005 under the name Tarpon Capital Management. Earlier in his career Mr. Lamensdorf was an equity trader/market strategist for the Bass Brothers’ trading arm. He managed a short only portfolio in addition to co-managing a $1bil hedging program. He also served as in-house market strategist for the entire internal and external network of Bass Brothers money managers.
The Investor Intelligence Short-Term Composite Indicator has proven to be a valuable tool for short-term market timing ever since it was developed in the 1960s. A reading of over 70 means the general index has become oversold. Below 30, it has become overbought. Three weeks ago, as shown in the chart below, it was at a very oversold 4, a reading that proved to be very accurate considering the subsequent stock market bounce. The recent market bounce has rapidly moved the indicator to overbought levels. This recent chart shows the indicator at 67.5 level, but it is probably above the oversold 70 reading after a subsequent market bounce. The fast-moving pace of this indicator is another clear warning sign that the market continues to be highly volatile, and very risky. We recommend investors lighten their stock portfolios. We expect more and bigger downward corrections than the one that occurred in the fourth quarter before stocks reach oversold levels that would trigger a durable, longer-term rally.
We use investor sentiment as a contrarian indicator of where the market is headed since investors are usually wrong. As we pointed out in last week’s sentiment report investors were registering extreme caution and fear just before the equity markets’ recent big upward moves. Now this week, continuing the trend of a week ago, investor sentiment has gone from fearful to neutral, but moving toward resistance levels. That, as we said in our last report, indicates smart investors should exercise caution by taking recent gains and reducing exposure.
The CNN short-term Fear/Greed was in the single digits three weeks ago, meaning investor sentiment was very fearful. This week it climbed up to 43, well into neutral sentiment territory but slowly moving toward resistance levels. The Ned Davis Research short-term gauge also bounced quite a bit to a neutral 44 from very fearful single digits three weeks ago.
Intermediate-term sentiment also bounced quite a bit. NDR crowd sentiment moved up to a current neutral reading of 55. The Investor Intelligence Bulls/Bears poll of market newsletter writers jumped to 43% bulls while bears retreated to 26% from 34%. Three weeks ago the bulls/bears spread was a negative 5. The spread is now well into positive territory at a positive 17.
The extreme negative sentiment that created the recent bottom has now evaporated as stocks moved higher. The market remains in a fragile state with many stocks recovering to their resistance levels of oversupply where sellers outnumber buyers, putting downward pressure on stock prices. Typically bottoms are created with a series of corrections. And we are not there yet. The fourth quarter down move is only one of many more that we expect before stocks reach the oversold levels that would trigger a durable, longer-term rally.
The chart below represents trading in the Financial Select Sector SPDR ETF (XLF) with a portfolio of the big-name banks and other financial institutions, a major stock sector for obvious reasons. Looking at the XLF chart over the last two years as a proxy for the financial stocks we can see that a very negative price pattern has developed. These stocks are being sold with very heavy volume and bouncing with very light volume. This is a dangerous trend because it shows that the large institutions are exiting this group. And using rallies to sell. Until the price action improves for the banking sector, I will find it hard to get bullish on the market over the longer term. Typically during times of major selloffs there will be periods when stocks become oversold, resulting in some bounce backs. While bear market bounces can be fast and furious, they also are typically short lived.
We use investor sentiment as a contrarian indicator of where the market is headed since investors are usually wrong. So just before the recent big downward moves, investors were extremely fearful. And what do you know? The market moved up. Now after the more recent moves up, investor short-term and intermediate-term sentiment has become more neutral, heading toward resistance levels. That indicates this may be a good time to take recent gains and reduce exposure.
The short-term CNN/Fear Greed moved from an oversold to an almost neutral 32. Similarly, the Ned Davis Research short-term gauge moved up 8 to 41. While not over bought they have both moved to a more mid-range at this point.
Intermediate-term sentiment also had some large upward moves. The NDR crowd sentiment moved to 50 from 41. Results from the Investors Intelligence poll of newsletter market writers shows bullish sentiment increased to 33% while the bears backed off to 27%.
The general market has had a large bounce, and sentiment has lifted with the market from oversold toward resistance levels. Which is a logical spot to reduce exposure.
Selling climaxes occur when a stock makes a 12-month low but then closes the week with a gain. They are a sign that stocks are going from weaker to stronger, more sophisticated hands. Buying climaxes occur when a stock makes a 12-month high but closes the week with a loss. They are a sign of a stock going from stronger to weaker, less sophisticated hands. This chart from Investors Intelligence shows an extraordinary number of stocks with selling climaxes compared to last year when buying climaxes were signaling stock declines. Work by Investors Intelligence shows that sellers into buying climaxes and buyers into selling climaxes are right about 80% of the time after