Are Bulls Getting Ahead of Themselves?

(page 2 of 2)

From Standard & Poor's Equity Research

We are excluding high readings when they occur very near an intermediate-term bottom and only looking for high levels of speculation when the market has gotten extended. As of Wednesday, we have seen six straight readings above 149% with a high of 177% on October 8. This was the highest and most speculative condition since March 2004.

The ISE Sentiment Index is also starting to exhibit an uncomfortable level of speculation, and like the above mentioned indicator, it has been an early warning of many intermediate-term summits. This index is a measure of investor sentiment calculated by comparing the number of opening long call options to opening long put options on the International Stock Exchange. The measure only considers the purchases of customers and does not include the purchases made by market makers, as customers are thought to be the best measures of sentiment. The index hit 187 on October 8, exceeding the levels hit in July 2007, just prior to the market rolling over. The 21-day ISE index is up above 140, not far from the peaks in July 2007 and December 2006. Many times, the market does not peak until the ISE sentiment index peaks and starts to head lower.

Put/call (p/c) ratios have fallen quite rapidly of late and are at or near levels that have preceded market tops. The 10-day total CBOE p/c ratio is down to 0.87 after peaking at 1.29 in mid-August. We view an extreme on the 10-day p/c ratio to be below 0.85, so we are very close. However, these ratios can get oversold and stay low for many months before prices peak out. Many times, market tops occur when these ratios bottom out and then start to head higher, as the trend of placing bullish bets changes and investors start to take more bearish bets.

Investor's Intelligence poll is showing 60.2% bulls and only 21.5% bears. This is the highest percentage of bulls since December 2005 and the lowest percentage of bears since July 2007. When we have seen a dramatic disparity in this poll among the bulls and the bears over the last four years, the market was able to continue higher but gains were for the most part, already behind you.

While we think the trend is still higher, and we see additional gains as we move further into the fourth quarter, we think price volatility is going to increase, as price gains will become tougher and tougher to achieve. We believe risk is rising, but think it is too early to abandon ship.