Several Reasons To Remain Open To Bullish Outcomes For Stocks

July 28, 2015

Fear Has Lots Of Company

As we noted in “What Do 1987, 2003, 2009, And 2015 Have In Common?”:

When investor sentiment reaches extreme levels, it can be a contrary indicator for the stock market. For example, the highest bullish reading in the history of the American Association Of Individual Investors (AAII) Sentiment Survey was 75% bulls before the dot-com bubble popped in 2000. To give you a reference point, the average over the life of the AAII survey is 39% bulls. Sentiment readings can also be helpful when they reach extreme levels of skepticism.

The CNN Fear & Greed Index was sitting at an “extreme fear” reading of 7 during Monday’s session. Mid-day on Tuesday it was still sitting at an extremely fearful reading of 15. This type of reading looks nothing like what we would expect to see near a major market peak; we would expect just the opposite…extreme optimism (see the 75% bull reading before the 2000 market peak).

Are There Other Reasons To Keep An Open Mind?

The answer to the question above is “numerous”. In addition to the CNN Fear & Greed Index, a record for investor skepticism, dating back to after the 1987 stock market crash, was recently broken. When markets consolidate, it speaks to indecisiveness or a more equal battle between bulls and bears. We are all familiar with the expression “the market needs to consolidate its gains”. Thus far, 2015 has produced a rare pattern of consolidation similar to ones not seen since 1904, 1934, and 1994. As noted in the table below, all three historical periods of consolidation were followed by big gains in the stock market.

Want More Details?

This week’s video provides some additional insight into the “reasons to keep an open mind about bullish outcomes” table shown above. It also covers recent observable damage to the bullish case.

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

Video

Video

How Can We Use All This?

Any data that tells us to keep an open mind about better than expected outcomes must be confirmed by the stock market; something that has not happened yet. For example, if the stock market is to rally for the next few months in a surprising manner, that is not possible as long as the S&P 500 fails to make a higher high above 2,134. Our market model does not make decisions based on what “may or may not happen”. Therefore, the only real value to the table and video above is to help us remain open to and prepared for all outcomes (bullish and bearish). A few reasonable S&P 500 guideposts relative to improving bullish probabilities include 2096, 2107, 2116, and 2134. Each push above a guidepost level improves the odds for the bullish case. Below these levels, the expression “the market has some work to do” applies.

Most Recent Comments Via Twitter

July 27, 2015

You can access them here (@CiovaccoCapital). You do not need to know anything about Twitter to view our comments or use the links to view charts.

Bearish Cracks vs. “Be Patient” Facts

July 25, 2015

Topics Shown Below Video Player

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

Video

Video

  1. Last 28 Months – Fed Policy Side Effects?
  2. Observable Deterioration
  3. “Be Patient” Evidence
  4. After A Similar Consolidation Period In 1904, What Happened?
  5. After A Similar Consolidation Period In 1934, What Happened?
  6. After A Similar Consolidation Period In 1994, What Happened?
  7. Did Sentiment Set Another Skeptical Record?
  8. Weak Transportation Average – Showstopper?
  9. Weak Breadth – A Bull Killer?
  10. Is The Fractal Analysis Still In Play?

What Do 1987, 2003, 2009, And 2015 Have In Common?

July 21, 2015

“Stocks Are Going Nowhere In Next Few Years”

If you have been involved with the markets over the past thirty years, you may find the sentiment statistics described in this article as the most surprising you have ever seen. Recent investor sentiment readings have reached levels of skepticism not seen since 1987, 2003, and 2009. If you know your market history, you also know those are the three best buying opportunities over the last 30 years.

Sentiment Can Be Helpful Near Extremes

When investor sentiment reaches extreme levels, it can be a contrary indicator for the stock market. For example, the highest bullish reading in the history of the American Association Of Individual Investors (AAII) Sentiment Survey was 75% bulls before the dot-com bubble popped in 2000. To give you a reference point, the average over the life of the AAII survey is 39% bulls. Sentiment readings can also be helpful when they reach extreme levels of skepticism, which is the topic we will explore in more detail below and tie it into the present day.

This Has Happened Only Three Times Since 1995

The eight-week moving average for percent bulls in the AAII Sentiment Survey recently dropped to an extremely low level in 2015, a level seen only two other times since 1995. The other two times were two of the best periods to invest in the last thirty years; early in 2003 and early in 2009.

In the chart above it is important to note we did not pick the comparison periods; the data selected the periods. The comparison is based on facts, not opinions. Since 1995, the recent reading has been seen only three times; 2003, 2009, and 2015.

Was 2003 A Good Time To Invest?

With similar skeptical sentiment to what we have seen recently in 2015, the spring of 2003 offered a great investment opportunity from a short-term perspective. As shown in the chart below, despite the “stocks are going nowhere” sentiment of the day, the S&P 500 rallied from 800 to over 1100 in less than a year (a gain of over 37%).

2003: From A Longer-Term Perspective

If you would have asked the average investor in 2003:

Is it possible for stocks to rally sharply over the next four years?

A common answer, based on the sentiment of the day, might have been “no way, not going to happen”. It did happen as shown in the 2003-2007 S&P 500 chart below:

Was 2009 A Good Time To Invest?

With similar skeptical sentiment to what we have seen recently in 2015, the spring of 2009 offered a great investment opportunity. In the wake of extreme investor skepticism, the S&P 500 rallied from the March 2009 intraday low of 666 to over 1200 in a little over a year.

What About Weak Market Breadth?

Regardless of what recent sentiment says from a probability perspective, you may feel it does not matter since market breadth in 2015 has been noticeably weaker. This week’s video examines the questions:

How long and how far can stocks rise with weakening market breadth?…Is it a showstopper?

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

Video

Video

Easy To Understand Skepticism After 1987 Crash

For those not familiar with Black Monday, the S&P 500 dropped over 20% in one day. Therefore, it is very easy to understand investor skepticism reached extreme levels after the 1987 stock market crash. What is surprising is that 2015 investor skepticism has reached an extreme level not seen since the period following the 1987 crash. From MarketWatch:

For the past 15 weeks, neutral sentiment in the AAII Sentiment Survey has registered above 40%, tying a record set in the wake of the Black Monday market crash of 1987. Charles Rotblut, editor of AAII Journal, has noted that unusually high readings of neutral sentiment typically coincide with better-than-average returns for the S&P 500 Index

Similar Sentiment Post-Black Monday

If the record for weeks above 40% neutral sentiment is shared by the period following the 1987 crash and 2015, a logical question to ask is what happened next in 1987? The answer is stocks went up, not down.

1987: How About From A Longer-Term Perspective?

With extreme levels of investor skepticism, those who stepped outside of the 1987 groupthink category and remained with the stock market were handsomely rewarded. If we asked someone after the 1987 crash “what are the odds that stocks rally sharply over the next thirteen years”, we may have been hit with a “have you lost your mind?” response. Despite the widespread skepticism about stocks, the S&P 500 came off the 1987 lows and rallied for the next thirteen years.

2015: No Way Stocks Can Rally!

Things are awful in 2015: Apple is down after hours, Greece is still a mess, the Fed is getting ready to raise rates, and earnings have been weakening. There is no possible way that stocks can rally, right? The market will decide, but things looked horrible after the 1987 crash, after the dot-com bust, and after the financial crisis as well. Did stocks tank in those three cases with similar sentiment to the present day? No, stocks did not follow the path that most anticipated. Instead of falling, they not only rose, but rose significantly.

But, 2015 Is Different From 1987, 2003, and 2009

Yes, that is true. The same comment applies to all historical analysis (bullish and bearish). This article has looked at two indisputable facts:

  1. The eight-week moving average for percent bulls in the AAII Sentiment Survey recently dropped to an extremely low level in 2015, a level seen only two other times since 1995. The other two times were two of the best periods to invest in the last thirty years; early in 2003 and early in 2009.
  2. For the past 15 weeks, neutral sentiment in the AAII Sentiment Survey has registered above 40%, tying a record set in the wake of the Black Monday market crash of 1987; also one of the three best times to invest in the last thirty years.

We did not cherry pick the data. The data picked the periods; 2015, 2009, 2003, and 1987.

AAII Survey Not The Only Evidence

We have seen similar and extreme bearish sentiment readings from other sources. For example, the CNN Money Fear & Greed Index was at an “extreme fear” reading of 22 a week ago.

Investor’s Intelligence Survey Also At An Extreme Level

Ryan Detrick points out in a July 19 article that the Investor’s Intelligence Survey recently hit an extreme and rare correction percentage greater than 40%, meaning over 40% of newsletters believe a correction is coming in the stock market. Ryan Detrick’s article shows S&P 500 returns have been favorable following such an extreme “correction” reading. From Investor’s Intelligence:

We study over a hundred independent market newsletters and assess each author’s current stance on the market: bullish, bearish or correction. Since we have had just four editors since inception, there has been a consistent approach to determining each advisors stance and his prior viewpoint.

How Is This Analysis Helpful?

From our perspective, this analysis is not about predicting what stocks will do next. The value is simply that it helps us keep an open mind about all outcomes, bullish and bearish. If we have an open mind, we can put plans in place for bullish and bearish scenarios. Experience says it is dangerous to decide in advance what the market is going to do, since it often does just the opposite. For now, the primary trend in stocks remains up and the S&P 500 is stuck in the same range it has been for months. If a correction is on the way, price will not miss it. We are happy to adjust if and when needed. Given what we know today, the evidence still calls for a equity-heavy allocation.

Recency Bias May Be A Big Factor In 2015

Why are investors so skeptical today? There are many factors in play, but one of them may be recency bias. Investors “have seen this before”.

Stocks rallied into the 2000 high, and then crashed. That was followed by a rally into the 2007 highs; that too, was followed by a stock market crash. From the 2009 lows, stocks have rallied and now it must be time for them to crash again, right? History and the charts say that assumption may turn out to be inaccurate. Only time will tell, but a detailed analysis, “Stocks Could Surprise Significantly On The Upside In The Next Fifteen Years”, aligns with the sentiment analysis presented here and tells us to keep an open mind about all outcomes.

Market Breadth And The Weight Of The Evidence

July 18, 2015

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

Video

Video

Video Will Be Posted Saturday Morning

July 17, 2015

Many interesting charts and will cover market breadth.

Most Recent Comments Via Twitter

July 15, 2015

You can access them here (@CiovaccoCapital). You do not need to know anything about Twitter to view our comments or use the links to view charts.

What Are The Odds Of A Bullish Resolution?

July 11, 2015

Video looks at:

  1. Support (numerous markets)
  2. Trends vs. patience
  3. European bond yields (fear)

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

Video

Video

Video Via Link

July 11, 2015

Video should be available between 2:30 and 3:30 am EDT (Atlanta) Saturday morning. You can find it here.

Basic Concepts And The Model

July 8, 2015

We make decisions based on the weight of the evidence.

The comment below from a June 23 post still applies:

“Are lower highs and lower lows always a big deal? Not necessarily, since they happen frequently. “

Lower highs and lower lows are relevant, but they are one of many factors to consider. Support is relevant, but it is one of many factors to consider. Trading ranges are relevant, but they are one of many factors to consider.

Support, higher highs/higher lows, lower highs/lower lows, and trading ranges are used in our videos to help illustrate basic concepts.

The model uses thousands of inputs to balance the desire to stay invested with the need to protect capital when the odds become less favorable. It is not a binary process of “all in” or “all out” based on a lower high/lower low, trading range, or any level of support.

When the odds become unfavorable on a 60-minute chart, it does not mean they are necessarily unfavorable on a daily chart. When the odds are mixed on a daily chart, they may be much more favorable on a monthly chart. The market model considers all of them. The rules and allocations are based on all the inputs.

If we focus on one factor on one timeframe, we are not getting a complete picture of the market’s risk-reward profile from an investor’s perspective. If we focus on one factor on one timeframe, we are assuming that one factor is a foolproof magic bullet. There is no such thing as a foolproof magic bullet, especially when an input is viewed in isolation.

The model is based on hard data and rules, rather than opinions about what may or may not happen next. No one knows what will appear in tomorrow’s news cycle. More importantly, no one knows how the market will react to tomorrow’s headlines, which is why we monitor and adjust, rather than anticipate and hope.

The market model is much broader than support, higher highs/higher lows, lower highs/lower lows, and trading ranges. There are many ways to approach the markets. The comments above relate to our approach, and may or may not apply to other value-add methods.