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There was a powerful uptrend in the stock market from September 2010 to February 2011, interrupted by one correction in November. I have anecdotally observed that 1344 exceeded the price target that many were expecting before another correction would ensue.
Throughout much of this trend, as early as December when the S&P 500 was in the low 1200s, high levels of bullishness, measured by investor polls and option put/call ratios, were often quoted as a reason to expect a 5% or greater correction. I was also guilty of these forecasts, embarrassingly early.
What have I learned? For anticipating market turning points, extreme bullish or bearishness is only part of the sentiment picture. This sentiment sets the conditions for what I am hypothesizing is a better sentiment-based timing tool—that is, capitulation. Synonymous with surrender, this is the preferred term in finance for two similar behaviors. First, capitulation is when investors who have held on to positions during a bear market with the tenet that “prices always go back up,” finally cannot endure the pain of seeing the value of their accounts drop, and decide to sell. This is an event that defines a primary trend. Smaller trends and turning points can be affected by the second type of capitulation, in which the callers of a bottom in a bear market give up and turn bearish, or the callers of a top in a bull market give up and turn bullish.
It is not extreme sentiment that will cause the market to turn, but rather, capitulation. One would expect capitulation to occur in an environment of extreme sentiment. As long as there is a significant enough group of individuals calling for a top, there may be 1) short sellers and 2) buyers on the sideline, not wanting to enter at a top. A top occurs once there are no buyers left—investors on the sidelines can still buy and shorts must buy to cover positions. These two groups must be converted before the actual top is printed.
A great and sad irony results from these phenomena. If capitulation is a necessary condition for a top or a bottom, then the market will not turn until it occurs. Think about that. As long as a group of individuals hold on to their belief that the markets will turn, the markets won’t turn. The majority’s conviction must be broken because this conversion, ipso facto, caps off the trend.
Sometimes, capitulation is identifiable by major spikes in volume coupled with parabolic moves in what are called blow-off tops and panic bottoms. There are no polls set to capture this type of surrender, per se. What one must identify is the conversion of bulls to bear or of bears to bulls, not the absolute level of each. To do so, one must scout for viable anecdotal evidence. Perhaps technical tools can be devised to measure this conversion.
In summary, in an environment of extreme sentiment, one must look and wait for capitulation in order to better time a turning point. For this to happen, I hypothesize that the majority of countertrend forecasters or traders, by necessity, have to convert. Until they do so, an established trend will continue.
(To read other market-themed essays, please visit my site .)
AAII Investor Sentiment for the week ending March 9, 2011 showed little change over the prior report. Those with a bullish outlook over the next six months fell to 36.0% versus 36.8% the prior week and below the historic level of 39.0%. Those with a bearish outlook fell to 32.3% versus 33.1% in the prior week and above the historic level of 30.0%. This report has correlated very well with the SPX and implies a move down in equities in the near term. The question now becomes though is this yet another correlation that has broken down?
Submitted by Macro Story. If you wish to read more, please visit - MacroStory.com
The COT Report for the week ending March 1, 2011 is a rather interesting one. Most important, oil looks poised for further upside. The commercial net position has gone extremely net short (remember, commercial shorts strength and buys weakness). Copper on the other hand looks to be rolling over in terms of how commercial traders are positioned. Both of these should put downside pressure on the SPX.
The USD on the other hand is a tricky one to read. There are two USD charts below, one of commercial net and another non reporting net (small retail). Both of these charts imply further USD weakness but non reporting has gone short rather aggressively which could be the fuel needed for a decent squeeze in the face of the excessive talk about the end of the USD. Additionally the divergence in positions between commercial and non reporting is at its widest in well over a year. The group think trade is further downside weakness but the opposite may in fact happen. On the other hand the USD did just break a three year trend line.
Submitted by Macro Story. If you would like to read more, please visit - MacroStory.com
Here's the situation for dear old Unc. He is outside in the cold, looking in. Behind him are the 3 Snowmen (let's see who remembers what they represent) out in the yard, awaiting their time. In the warm, toasty house the revelers are punch drunk, doing the twist and making out in the corners. The music is loud, and it sucks by the way. Pure canned, disco crap.
Every once in a while, a group of hotties sees Unc staring in the window and they mock and giggle amongst themselves. The real men are inside, doing the shuffle and giving pick up lines, not to mention doing another kind of lines. This is a hell of a party and no one wants to leave. Too much fun. No worries about the details of every day life. No worries about why they are even at the party. Party on… til there ain't no party no more.
