Stocks: Between a Rock and a Hard Place

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From Standard & Poor's Equity Research

The Hang Seng index has moved sharply back to the upside, and is only about 2% below its July 24 all-time high of 23,473. The 18-day correction of more than 13% has all but been erased in just four trade days. Even more remarkable, the FXI is in record closing territory today, having recovered all of the 16% it lost during the first half of August. If U.S. investors are worried about growth from the east, it certainly isn’t being reflected in share prices.

European stock indices have been a bit slower recovering from the correction, and our primary concern is the action of the FTSE 100. The index remains below its 200-day exponential average and has broke below major trendline support off the lows since 2003. A longer term crossover system we like is still suggesting that the market is in a bull phase, but is a little too close for comfort. The 17-week exponential moving average has not crossed below the 43-week average, but it is only about 60 points from doing so. The moving average crossover system has worked well in the past, both in bull and bear markets. The 14-week RSI had fallen below the 40 level for the first time since the last bear market, after hitting 37.50 recently. The RSI has popped back above the 40 level, which has provided nice support for the bull market.

In our opinion, one of the amazing statistics during the correction was that the percentage of new NYSE 52-week lows hit an extreme 32.8% on Aug. 16, almost equaling the 33.2% seen on Aug. 31, 1998. During 1998, the S&P 500 fell about double what it fell this time. The only other times when this level has exceeded 30% was just before the bear market low in 1990, on Oct. 19 and 20, 1987, and in September 1981.

When we have seen new lows exceed 20% of issues traded in the past, we often times have a retest of the lows. In addition, we many times will see a series of positive divergences or lower highs of new lows/issues traded as the market builds a base. New lows have plummeted to less than 1% very quickly, but we have yet to trace out a series of lower highs with respect to new lows.

Market survey polls have shown a quick drop in bullish sentiment as traders, portfolio managers, and newsletter writers jump to the bearish camp. The Consensus poll has dropped to 41% bulls from 78% back in May.

In the last couple of weeks, the big changes have occurred in the Investor’s Intelligence poll. Over the last four weeks, bearish sentiment from the II poll has jumped to 37.4% from 18%, an incredible 19.4 percentage points. This is the largest 4-week jump in bearish sentiment since February 1990. Bullish sentiment has declined to 40.6% from 53.9% in the same period, the largest drop since March 2004. The last time we saw bullish and bearish sentiment this close together was near the market low in the summer of 2006.

Last week’s Trader’s Commitment (COT) report showed some extreme readings in sentiment as well. Small speculators (dumb money) had reduced their long positions in the S&P 500 e-mini contract to only 51% of the total, down from 76% in May. Small speculators in the Russell 2000 e-mini contract actually have a net short position, which is very similar to where they were positioned near the bottom of the market last summer.

Arbeter, a chartered market technician, is chief technical strategist for Standard & Poor's .