Are Investors Not Scared Enough?

12/02/2008 1:00 pm EST


Bernie Schaeffer

Chairman and CEO, Schaeffer's Investment Research

Bernie Schaeffer, editor of the Option Advisor, says professional and individual sentiment isn’t bearish enough to indicate a market bottom has been reached.

And so it goes, with the Standard & Poor’s 500 index now down 44% for the year, 48% from its October 2007 peak, and trading at its lowest level in 11 years.

So how can our own Ryan Detrick be concluding that people are not “scared enough”?

[A few] weeks ago, the American Association of Individual Investors (AAII) survey was showing an astounding 44% bulls compared to just 33% bears.
And the ten-day moving average of “buy to open” call volume on the International Securities Exchange is still about 20% higher than the corresponding put volume. This is in marked contrast to the situation at the 2002 market bottom, when put volume exceeded call volume by 10%. The VIX, while certainly at elevated levels, is [still] below its October peak.

But perhaps the strongest indication of lingering complacency in the wake of a stock market implosion is the current advice of Wall Street equity analysts. The leader of [Schaeffer’s Investment Research’s] quantitative group, Joe Sunderman, [said recently]:  

“Analysts have not significantly changed their posture during the past several months. Despite the S&P 500 Index shedding more than 40% year to date, the percentage of Buy ratings has been fairly steady. More specifically, Buy ratings have trickled lower during the last year or so from a high of 47.9% (October 7, 2007) to a current reading of 45.4%.

“According to Dirk Van Dijk of Zacks Research, ‘earnings expectations are collapsing for both the fourth quarter and 2009.’ Thus, it will be noteworthy to see if the declines in earnings expectations will lead to future downgrades on US equities in the coming months.”

To this, I will add:

1. The percentage of analyst Buy ratings as the market was rallying off the major market bottom in 1982 hovered in the 25% zone for almost two years, compared to the current level of about 45% Buys.

2. While the Sell percentage has risen steadily this year, it remains below 10% (about a third of the level of Sell ratings in 1982-1984. And in that 1982-1984 period, the percentage of Sell rating eclipsed that of Buy ratings on numerous occasions.

Signs of optimistic sentiment or outright complacency are exactly what you don’t want to see if you’re hoping for a market bottom. In this connection, I’ll note that not only have the key long-term moving averages that I’ve emphasized in recent months been decisively penetrated, but [the market recently] sliced through the 788 level on the S&P 500, which represents half of the October 2007 peak at 1,576.

There is often significant support at these “half-high” levels after major declines, and the jury may not yet be out on the 788 level still holding as support. But should it not hold, we are likely to have some very serious additional pain ahead.

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