The Percentage of Bears Is on the Rise

06/04/2010 12:01 am EST

Focus: STRATEGIES

The chart posted below reflects the Investors intelligence survey as of May 25, 2010.

Each week, Investors Intelligence takes a survey of 140 financial newsletter writers and compiles the data into several charts. One of their charts plots the percentage of bears each week (see graphic below). During the most recent market top in April 2010, the percentage of bears bottomed out at the 17 % range. The survey is considered to be a contrarian indicator with extremes in either direction, marking tops and bottoms.


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In April 2010, the percentage of bears was near extreme lows, hovering around 17%. This wildly bullish sentiment marked a peak in the market in late April. Notice how the falling channel of the percentage of bears has broken out with the recent selloff in the market, showing the percentage of bears is gradually rising. Also note the divergence that has formed with the Standard & Poor‘s 500 weekly chart (Figure 2). The S&P 500 moved to new highs at the end of April 2010, exceeding its January 2010 peak, but the percentage of bears failed to move to new lows. The higher low on the percentage of bears completed a divergence with the S&P 500.

Upon close examination of the S&P 500 daily chart, you will notice a possible head-and-shoulders top forming.


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If the S&P 500 rises up to form a right shoulder, it will allow the percentage of bears chart to fall back and test the broken trend line in the form of a backtest. If the S&P 500 produces a lower high and completes the pattern, it would allow the percentage of bears to successfully complete its backtest and begin a new rising trend. However, the evidence shows that the percentage of bears is in a new uptrend because it has produced a higher low and a higher high.

Additionally, the breaking of the channel constitutes a change in trend with the percent of bears in a new uptrend. It only stands to reason that the stock market has likely begun a new long-term downtrend.

The percentage of bears index bottomed out and began to rise in late-April 2010 when the stock market began to erode over the debt crisis in Europe. This contrarian indicator is further evidence that this entire run-up from March 2009 has been greatly impacted by artificial growth spurred by cheap credit (low interest rates), stimulus money, bailouts, and government incentives. This rally really looks like a 1930’s-style bear market rally. After the bottom dropped out of the
stock market in 1929, there was a strong rally for a while, which was very similar to the March 2009 run-up. But once the pseudo rally had concluded, the market resumed the decline and fell into the abyss.

Take a look at the bottom that formed on the percentage of bears index during the 2007 market top. It looks very similar to the divergence that just formed between January and April 2010. The percentage of bears chart suggests that the market has topped. Should the head-and- shoulders scenario play out, we should expect to see the percentage of bears index begin to trend higher and the market begin to trend lower.

By Ron Walker of TheChartPatternTrader.com

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