What the Mass Media Is Missing

11/03/2009 2:51 pm EST

Focus: MARKETS

Bernie Schaeffer

Chairman and CEO, Schaeffer's Investment Research

Bernie Schaeffer, senior editor of the Option Advisor, points to bullish technicals and rampant popular pessimism as hopeful signs.    

Our Senior Quantitative Analyst Rocky White [recently] updated and assessed our long-term market indicators in an internal e-mail to our traders and analysts and I’d like to take this opportunity to share some highlights of his report with you.

Rocky summarizes the weight of the evidence from our long-term indicators as follows: “The long-term indicators have a strong bullish bias. The long-term technical indicators (RSI, MACD and Stochastics) have all given official buy signals. Also, the S&P 500 Index has crossed above the potential resistance of the 80-week moving average. The S&P’s 50-day buy-to-open (BTO) put/call ratio is heading upward, implying that money is flowing into the market. Despite the strong market over the last several months, we have seen plenty of bearish magazine covers, especially from non-financial publications, and in various articles.”

I found Rocky’s comment about the takeout of the 80-week moving average to be particularly interesting and particularly significant. The 80-week trend line equates to a 20-month moving average, and I was recently alerted to the fact that a number of bearish technicians had been hanging their hats on the fact that, as of about a month ago, the 2009 rally had not propelled the S&P above its 20-month level. Note from the accompanying chart how the 20-month supported the S&P throughout the bull market of the 1990s, was then broken in November 2000 ahead of a sharp two-year market plunge, was taken out in June 2003, supported the entire bull run into 2007, and was then broken again in January 2008 to serve as a perfect precursor of the 2008-2009 bear market. So the fact we’ve taken out the 20-month moving average this month has got to be very encouraging from a technical perspective…

Rocky’s comments on the “buy-to-open put/call ratio” for the S&P are more complex to explain, but I’d like to take a shot at it for you because of its importance to the bullish case. Basically, we’ve studied the data feed from the Chicago Board Options Exchange (CBOE) for “buy to open” (BTO) transactions on their S&P 500 index options, which means opening transactions that are initiated by option buyers. And we’ve found that increases in S&P BTO put activity are highly correlated with market rallies, while decreases in this BTO put activity correlate with market declines.

Our interpretation is that BTO activity in S&P puts is driven by those who are accumulating long positions in the market and who are using S&P puts as a way to hedge their downside exposure. So in this sense, increasing S&P BTO put activity is an indication that stocks are under accumulation… There was some hesitation in this accumulation in the third quarter, but it has now resumed, with ongoing bullish implications for the market.

Finally, amidst this favorable combination of technicals and money flows, we have ongoing skeptical (and, in many cases, outright bearish) sentiment. Rocky cites bearish magazine cover stories, and one in particular worth mentioning is the cover piece in the October 19, 2009 issue of Time—“Why it’s time to retire the 401(k)”—which refers to the 401(k) as a “lousy idea” and a “financial flop.” As I’ve said endlessly in this space, the continued skepticism in the face of this powerful market rally (in this case, the outright loathing of a stock market-based retirement concept that had been almost universally accepted as gospel as recently as a few years ago) has ongoing bullish implications, as it’s a strong indication that there is still a substantial pool of sideline money that can power this market even higher.

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