Greed Is Good, But Fear Is Better

04/09/2007 12:00 am EST

Focus:

Mark Arbeter

Chief Technical Strategist, S&P Capital IQ

Mark Arbeter, Standard & Poor’s chief technical strategist, says the level of fear among investors suggests stocks could move higher later this year, and he cites a couple of recent historical parallels. 

It's not often we predict a spike higher, [but] certain technical measures we follow suggest higher [stock] prices could be in store later this year.

We're talking about the put/call ratio, which tracks options contracts purchased on the Chicago Board of Exchange. The ratio is used widely as a gauge of market sentiment.

Recently this measure hit an all-time high, suggesting Mr. Market had just taken a room at the Bates Motel-- a glut of fear, in other words. Interestingly enough, this occurred during what was by historical standards a relatively modest pullback. This excessive fear is, we suggest, bullish.

Then there are odd-lot short sales. Odd lots are quantities of shares that are less than the standard 100-share block and that are generally traded by novice investors. Short sales of odd lots indicate novices think the market is on the verge of a painful plunge. This bearishness by beginners is, likewise, bullish.

So, are higher prices in store? Owing to the swift decline in stock prices in all major US stock indices during late February and early March, there is little chart resistance overhead. By resistance, we simply mean levels on the chart where previous buying took place.

The first band of resistance for the Standard & Poor’s 500, from a 21-day price range, comes in at 1435, right near its recent rally point. Above that, the only real chart resistance is around the February recovery highs of 1450 and 1460.

While we all know that bull markets trend higher and bear markets trend lower, different slopes within the longer trend can develop. For instance, from March 2003 until March 2004, the slope of the S&P 500 was fairly steep at about 43 degrees. From March 2004 until July 2006, the slope was only about 18 degrees. Since the intermediate-term bottom last summer, the slope of the bull market has steepened, rising at an angle of about 34 degrees.

The implications of a steeper intermediate-term slope are clear: big gains to the upside and potentially a mini-blow off. We found a couple of cases in recent history that look somewhat similar to recent market action. They both occurred in the year after the four-year cycle low, which we are in now. These blow offs also happened after a strong, low-volatility advance, such as the one from August until February. In addition, they occurred right after a mini-shakeout. The first instance was in 1995-1996, when the S&P 500 exploded up 10.5% in 23 trading days. The second example was in late 2003/early 2004 when the index surged 12% in 55 trading days.

Again, we note the scenario sketched out above is just that--a possible scenario based on technical observations in the past. But it's one that bears watching.

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