The market is driving away investors due to the wild swings it is experiencing, but it’s investors who create the swings. In the first quarter, the market screamed higher and experienced one of its best three months of the 21stcentury. The rally was so strong that the S&P gained ground in all but two weeks of the first quarter, gaining 12%.
As good as the first quarter was for the S&P, the second quarter has been its mirror opposite, giving back 8.6% since the quarter started as all but three weeks have shown losses by the index. Personally, I think the market rally was overdone in the first quarter and now the pullback is overdone. Investors were way too optimistic during the first quarter, and now they appear to be way too pessimistic, even given this week’s bounceback on Wednesday.
Looking at the overbought/oversold indicators, the slow stochastic readings are the lowest they have been since March 2009 as the market was approaching the end to the bear market that gripped Wall Street from late 2007.
I have to ask, have the past two months been so bad that the slow stochastic readings should be as low as they were at the end of a bear market that saw the S&P lose over half of its value? Has the economy changed that much from the first quarter? I think the answer to both of those questions is no.
This weekly chart isn’t the only thing suggesting the market pullback has gone too far. Looking at three of my favorite sentiment indicators, all three are displaying overly pessimistic readings. The Investors Intelligence report measures the bullish percentage of newsletter editors versus the bearish percentage. The latest reading shows the bullish percentage has dipped to 34%, which is the lowest reading since September 2010.
The CBOE Equity Put/Call ratio measures the number of calls and puts traded on individual stocks on a daily basis. This particular indicator can vacillate wildly from day to day, so I like to look at a 21-day moving average to smooth out the wild daily swings. The 21-day moving average for the ratio has climbed above 0.79 for the first time since last August. A high reading indicates that option traders are displaying bearish sentiment.
The Rydex Nova/Ursa ratio is the third indicator showing pessimism is on the rise and perhaps overdone. The Rydex family of funds has the Nova Fund, which is a bullish fund and targets a return that is 150% of the return of the S&P 500. The Ursa fund is a bearish fund and targets a negative 100% correlation of the S&P 500. The ratio is simply the assets of the Nova fund divided by the assets on the Ursa fund. The higher the ratio, the more bullish investors are, and the lower the ratio, the more pessimistic investors are. The reading on Tuesday was 0.238, the lowest since last September.
Looking at the three sentiment indicators, you see all are showing the most pessimistic readings since last fall, right before the market rallied sharply. The chart is showing that the S&P is the most oversold it has been since March 2009, right before the index went on one of the best rallies in the last 20 years.
Add all of these factors up, and it looks like the S&P is ready to take off on its next bullish cycle. I look for a strong rally for the second half of the year, but let’s hope the investor sentiment doesn’t get skewed to the bullish side again too quickly.