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SENTIMENT JOURNAL: Market Strength Revives Bullish Sentiment
By Frederic Ruffy, Optionetics.com
8/15/2003 4:30:00 PM

http://www.optionetics.com/articles/article_full.asp?idNo=8900

Market Internals: Stocks moved broadly higher during the latest week of trading. The Dow Jones Industrial Average ($INDU) rose four times, fell once, and added 130 points. Volume was light, which is not uncommon during the month of August, but dropped off dramatically on Friday after the power outage made trading difficult in many northeastern states. In fact, on Friday, volume on the New York Stock Exchange [NYSE] was roughly half of its normal levels. Despite the lackluster volume, however, stocks held up well during the latest week of trading and market internals were mostly positive. In fact, market breadth, or the ratio of advancing to declining issues on the NYSE, was positive during all five trading sessions.

The Nasdaq Composite Index ($COMPQ) rose on four of five occasions and added nearly 60 points, or 3.5%. Wednesday was the Nasdaq’s only losing session but, even then, the composite index fell only fractionally and market internals were net positive. Similarly, the advance-decline ratio on the Nasdaq Stock Market was positive during four of five trading sessions and mixed Friday. Overall, tech stocks and the Nasdaq performed well during in the past week. Semiconductor, computer software, and Internet stocks were among the best percentage gainers.

Sentiment Data: While stocks made reasonable progress during the latest week of trading, a number of sentiment indicators suggest that bullishness has once again reached an extreme. From a contrarian perspective, the evidence of extreme bullish sentiment from the investing public, or the “crowd,” is a reason to be cautious. Obviously, stocks can continue to march higher even in the face of rising bullish sentiment and there is no sure-fire ways to predict the market tops. But, from a trader’s perspective, getting caught long (holding stocks or other bullish trades) at the end of a bullish trend can sometimes inflict some serious financial wounds that are difficult to heal. Therefore, as stocks move higher and the crowd grows increasingly bullish, the contrarian will take a more defensive approach and even begin looking for shorting opportunities in those groups or sectors that appear the most vulnerable for a move to the downside.

So, what are these signs of extreme bullish sentiment? The surveys of investor sentiment are showing high levels of bullishness among investors. According to the widely watched Investor’s Intelligence survey, bullish sentiment is up to 52% from 51.5% last week. Meanwhile, bearish sentiment fell to 19.0% from 20.8% the week before. Similarly, the American Association of Individual Investors [AAII] reports that 50.6% of those polled are bullish, compared to only 23.6% bearish.

In addition, the Nasdaq 100 Volatility Index ($VXN) closed below 30% on Friday, which matched its historical lows from mid-May of this year. The CBOE Volatility Index ($VIX) also fell back down towards the lower end of its range and approached the 20% level Tuesday. The drop in the two volatility barometers is generally considered a sign of bullishness or complacency among investors.

Put volume has been light. While drop is due in part to seasonal factors (August is generally slower than other months due to holidays), put activity was exceptionally light early this week. On Monday, only 1.05 million puts traded across the five exchanges (one of the lowest volume days this year), compared to 1.6 million calls. The extremely light put volume is an indication that few traders are hedging their bets, and it is therefore a sign of relatively high levels of complacency or bullishness among options traders.

Plunging last week, DDX is one of the week’s best percentage gainers. It finds support at the 105 lower, but weekly MACD hints at lower prices to come.

Chip stocks lead the markets advance, but SOX has major resistance at current levels. A break above 410 breaks an ascending right triangle and has bullish implications.

The Japan index performs well in the latest week of trading and is testing last month’s highs near 105. Broadening top formation is bearish, however, and could be a double top pattern.

Small caps are the best performing group this week. It is a sign of positive market internals. However, weekly chart and MACD hint at reversal. Move above 480 is bullish.

The interest rate index rises, and that means bonds are falling. TNX rises to new one-year highs, but the gains are not being confirmed by RSI. Watch for reversal.

Oil service stocks are relatively weak, but the OSX is still in a bullish pattern. Resistance at 90. A move above that confirms the trend.

DRG stocks are one of the few groups not moving higher this week. The drug index is caught in a bearish funk and is testing support at 310. A move below 300 spells trouble.