Beth's Bets: A Sentiment Trio

07/23/2004 12:00 am EST


Beth Gaston Moon

, Schaeffer's Investment Research, Inc.

"Our relative-strength filter, seeks stocks with a combination of bearish sentiment and strong technicals," says research analyst Beth Gaston of Schaeffer's Investment Research. "These factors have historically been a recipe for continued strength in the underlying shares."

"One of the power tools available to us at Schaeffer's Investment Research is our Sentiment Powertool, a relative-strength filter that seeks out equities that have been asserting their strength against the broader market for two months or more. From our Expectational Analysis perspective, future strength is a safer bet when there is a ‘wall of worry’ in place for the underlying equities to scale. This ‘wall of worry can be constructed with pessimistic sentiment from the options crowd, as evidenced by an unusually high put/call open interest ratio (SOIR). This is a comparison of open put positions (bearish bets) compared to open call positions (bullish bets). An unusually high reading indicates that bearish sentiment is the dominant opinion. Here, we profile three stocks that have shown on this filter. I plugged in the following variables for today's relative-strength filter:

"Hershey Foods (HSY NYSE) is familiar to this list. The firm is the world's leading candy manufacturer. On the fundamental front, the company reported first-quarter earnings late last month that topped analysts' expectations by a penny per share. This was the fourth consecutive positive earnings surprise for HSY. The stock has been on the rise for more than a year, gaining 45% over the past 14 months. Throughout its rally, HSY has benefited from the continued support of its 10-week and 20-week moving averages. These intermediate-term ascending trend lines have worked in tandem to help buoy the shares north. From a longer-term perspective, HSY is sitting atop double-barreled support at the 80 mark. This was previously a level of technical resistance in 2002, but acted as support on a short-term pullback last month. The 80 level is also home to the stock's rising 10-month moving average. Not only does HSY have a strong technical performance at its back, but it is not yet favored by speculative players. This pessimistic speculation is a positive sign in our contrarian view, as it suggests that not everyone has been convinced of the stock's potential. As such, there is additional buying potential available on the sidelines. Another sign of pessimism is the fact that the number of shorted HSY shares has been on the rise since September, as bearish investors wager on a future decline in the stock. If the equity disappoints the bears and moves higher, a short-covering situation could arise, adding fuel to the security's rally. Finally, Wall Street has failed to commit to the shares. Eighteen brokerage firms currently follow the stock. Seven (38 percent) of these firms keep HSY on their ’buy’ list, while 10 name the stock a ‘hold’ and one designates it as an outright ‘sell.’ The potential for future upgrades, therefore, is encouraging for the shares.

"Commerce Bancorp (CBH NYSE) manages nearly 300 branch locations, primarily in the northeastern regions of the US. Technically, in the last month, CBH caught support from its ascending 40-week moving average and bounded higher. The equity is now trading back above its 10-week and 20-week moving averages, which have completed a bullish crossover. CBH is now within striking distance of its former annual peak of 67.65, reached in early April. For the vast majority of the time since January 2000, CBH has outperformed the broader-market barometer. Other than a brief period in the first half of 2003, the stock has motored higher compared to the SPX. In fact, the stock's monthly relative-strength measure is near a multi-year high. Despite the stock's technical promise, there is a fair amount of pessimism brewing on the stock. We view this bullishly from our contrarian perspective, as bearish speculation, especially on an uptrending stock, provides the foundation for additional buying strength in the future. The put/call open interest ratio indicates a hefty amount of bearish sentiment emanating from the speculative crowd. What's more, following a 14% short-interest increase last month, there are currently 8.28 million CBH shares sold short, accounting for more than 11 percent of all CBH stock available for public consumption. At the equity's current average daily volume, it would take these bearish players almost eight trading days to cover their positions, should the stock continue to advance. This phenomenon, known as short covering, could provide added tinder for the equity's charge higher. Wall Street analysts are currently mixed on the stock's potential. Fifteen analysts currently follow CBH, eight of whom name it a ‘buy.’ There are five ‘hold’ ratings on the stock and two outright ‘sells.’ The stock's potential for brokerage upgrades is fairly attractive at this juncture.

"A new name on our filter is Whole Foods Markets (WFMI NASDAQ). On May 4, the grocer said it earned 54 cents per share in the reporting period, four cents above Wall Street's expectations. Same-store sales rose more than 17% during the second quarter, and yearly sales are targeted to climb between 18% and 22%. WFMI is the world's number-one natural-foods retailer. The firm currently operates about 145 stores. Technically speaking, WFMI has enjoyed a steady rally for the past year, gaining 90 percent since the end of June last year. Throughout its upsurge, the stock has benefited from support at its ascending 10-week moving average. The equity has displayed notable strength for more than three years, with an early burst of strength beginning in the second quarter of 2001. Since last August, WFMI has been buoyed by its five-month moving average. The shares are now just shy of an all-time peak. The security's monthly relative-strength measure has been gaining ground since the beginning of the millennium and recently achieved a new all-time high. Options players have failed to notice the company's fundamental promise or its technical strength. Also encouraging from a contrarian perspective are the 4.3 million WFMI shares sold short, which represents about seven percent of the stock's total float and amounts to a short-interest ratio of 5.8. Put another way, it would take these bearish investors almost six days to cover their shorted positions. Short-covering activity could provide WFMI with an additional boost. Wall Street has sided with the options crowd and has failed to notice the positive qualities of WFMI. Only three of the 13 analysts covering the stock have named it a ‘buy’ or better. If WFMI continues its rally, some of the nine ‘hold’ ratings or the one outright "sell" could be boosted higher."

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