Bearish Signs But Still a Bull Market

10/05/2009 11:34 am EST

Focus: MARKETS

Lawrence McMillan

Founder and President, McMillan Analysis Corporation

Lawrence McMillan, president of McMillan Analysis and editor of The Option Strategist, examines the evidence for a bearish resurgence and concludes we’re not there yet.

There’s an old saying that “they don’t ring a bell when it’s time to sell.” However, with the parade of bearish analysts on TV, it certainly seems like plenty of people think they heard a bell.

So, has “the” correction begun? Anything is possible, of course, but there is still plenty of upward price momentum in the Standard & Poor’s 500 index ($SPX). It remains above the trend line that connects the March and July lows. The rising 20-day moving average is at 1,040 as well. So, a close below 1,040 would be negative, but the major trend line is what truly demarcates this bullish phase, and it is currently near 1,000. (It closed at around 1,025 Friday—Editor.)

The equity-only put-call ratios continue to rise. Technically, they are thus on sell signals. However, they have been on these sell signals for some time. As we have repeatedly pointed out, when the put-call ratio is rising at the same time that the underlying ($SPX, in this case) is rising, that is evidence that hedging is dominant. Furthermore, the put-call ratios lose their predictive nature when hedging is prevalent.

How do they get back on track? Eventually, they start moving opposite to the market again, and then they are back “on track.” So, for example, if the current selling develops into a bearish trend and the put-call ratios continue to rise, they will be back on track, and the next Buy signal will be a valid one.

Market breadth has been very strong, keeping the breadth oscillators in overbought territory. Since we last published, both breadth oscillators traded at all-time highs When these oscillators have registered other all-time highs in the past, it has generally meant that there is more rally to come, and the market did rally for another week. [Recent] negative action, however, has pushed the oscillator down to the brink of sell signals. Previous breadth sell signals during this rally have not been particularly meaningful, as all corrections have been short-lived.

Volatility indices ($VIX and $VXO) both made yearly lows [recently], before the market reversed downward. The $VIX chart remains in a down trend and is thus bullish for the broad stock market.

A close above 27 by $VIX would break the down trend, but the four similar previous such occurrences this year have not resulted in a rising trend in $VIX—and that is the only way that $VIX would turn negative. (The VIX did close above $27 last Thursday and Friday—Editor.)

In summary, a seemingly large number of people have quickly turned bearish. However, unless we see some signs of intermediate-term sell signals—most noticeably a break of support in $SPX and a confirmed rising trend in $VIX—we will not be joining that bearish throng.

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