While bad news has roiled major indexes, S&P believes the worst of the market decline may have passed, based on technical conditions
From Standard & Poor's Equity ResearchAfter some pretty hairy moments of price testing during the week, we were pretty relieved Friday morning (Mar. 14) with the S&P futures up over 1%. It finally appeared that the market was in the clear and about to embark on an upside trajectory. Well, this market does not let you relax for a minute, as Bear Stearns (BSC) plunged in early trading, taking the S&P 500 down almost 37 points or 2.8% in the first half hour of trading.
We are clearly in a news-driven environment and believe strongly that the horrendous news flow will continue. However, we also believe that the worst of the market decline is behind us based on the technical conditions that have presented themselves over the last month or so.
Eventually, the market goes back to becoming a discounting mechanism and won’t be held hostage to the crisis of the day.
Of course, Friday morning wasn’t the only exciting part of last week. The Federal Reserve announced another package on Tuesday, Mar. 11, to try to stem the liquidity problems in the credit markets, and this was cheered very loudly by Wall Street. This package just happened to be released on the day following the S&P 500’s close at 1273, precariously perched just above the last piece of chart support from the panic lows in January at 1270. The Fed’s timing could not have been better, in our view, and we have seen this very timely Fed intervention in the past, and sometimes wonder whether they have a market technician on staff to tell them when the stock market needs a shot in the arm.
We still believe any strong break below 1270 sets off more fireworks to the downside and a fifth wave to the bear market. By the way, the Fed’s action set off the biggest one-day rally by the S&P 500 since October 15, 2002, propelling the index to a monster 3.7% gain. That happened to be only four days after "the" bear market low.
We think there was some evidence of capitulation late last week and early this week, although it was not the type of price freefall that most people think of. First, during the three-day decline into the lows on Mar. 10, there was clear dumping of market leaders, being high relative strength stocks that were holding up the best. These stocks, for the most part, came from the energy and materials sectors. Many times, near a market bottom, even the best looking stocks get thrown out with the issues that aren’t working. To us, this is a type of capitulation.
Secondly, there was a clear capitulation by newsletter writers based on the latest results from the Investor’s Intelligence (II) poll. It appears that these writers finally threw in the towel and turned bearish on stocks. We wonder what they have been watching all these months. The latest readings from II were in a word, dramatic. Bullish sentiment declined 10.8 percentage points to 31.1%. This is the lowest percentage of bulls on the II poll since October 2002. Bearish sentiment rose 6.7 percentage points to 43.3%, the highest since October 1998. This is the first time since 2002 that bearish sentiment has exceeded bullish sentiment on the II poll, and the spread of 12.2 percentage points favoring the bears is the most since October 2002. This huge one-week drop in bullish sentiment was the most since right after the market crash in October 1987.
The ISE Sentiment Index fell to 56 on Monday; the second lowest reading since the data began in 2002. We believe this indicates an extreme level of bearish sentiment as this is a call/put ratio. This ratio is based on individual investors opening bets in options, and many times, very low readings have marked important bottoms for the stock market. We have seen consistently low readings since the beginning of January, showing a high degree of fear by individual investors in the marketplace. These low readings have pushed the 21-day exponential average to a recent all-time low at 87 and the 50-day exponential average down to an all-time low at 95.
We got an extremely elevated reading on the CBOE total put/call (p/c) ratio on Monday, also indicating rampant fear over stocks. The CBOE p/c ratio rose to 1.48 Monday, one of the highest levels in the history of the data. This ratio on a 10-day and 30-day basis is quite high and is still in an uptrend, tracing out higher highs and higher lows. Many times, the stock market does not benefit from these extreme readings until the trend reverses to the downside and the bearish options activity unwinds as traders cover their puts and accumulate calls. The CBOE equity-only p/c ratio remains very high on a daily basis and has pushed the 30-day ratio to 0.80, the highest since October 2002, right near the bear market low.
The AAII poll is showing only 20% bulls, one of the lowest readings in over a decade, while bearish sentiment has risen to 59%, one of the highest readings since 1990. This poll fits in with what we are seeing in the Consumer Confidence data. That poll has fallen to 75, the lowest reading since March 2003, near the final low of the bear market.
The bond market has benefited from the weakness in equity markets, and the defensive shift has dropped the yield on the 10-year Treasury note to 3.42%, very close to the panic lows of 3.28% in late January. It is possible that yields are tracing out a double bottom, and we think if stocks ever get into gear, yields will rise. The TLT or iShares Lehman 20-year Treasury Bond Fund appears to be tracing out a bearish head-and-shoulders on both the daily and weekly chart. On the daily basis, the price pattern is very symmetrical. To complete this pattern, the TLT would have to break below the neckline down near 90. If this occurs, we could see a fairly large correction in bond prices and much higher yields, in our view. This would be okay, because we think it would correspond with a rally in stocks.