“On the sentiment front, we have noted during the past few weeks that negative sentiment among short-term traders is at levels that have coincided with major troughs during the past few years. But one concern that I have is that after buy-to-open put/call volume ratios on both SPX and Nasdaq 100 Index (NDX — 14,009.54) components peaked near the end of January, these indices are slightly below the levels they were at when their respective ratios peaked. This is not normal and potentially indicative of longer-term investors overwhelming traders who bought the dips a few weeks ago.”
- Monday Morning Outlook, February 22, 2022
In reviewing last week’s commentary, the excerpt above stood out. Even though short-term traders had become more bullish after reaching a pessimistic extreme, key equity benchmarks did not rebound as they normally do when traders have moved from extreme bearish posturing into a more bullish stance.
Moreover, there were early indications that traders were losing faith in a rebound and building bearish positions again, as buy-to-open put-call volume ratios on S&P 500 Index (SPX — 4,384.65) and Nasdaq-100 Index (NDX — 14,189.16) components were turning higher. Indeed, this was a red flag, as both the SPX and NDX fell below their respective late-January lows. Equities headed south to begin the holiday-shortened week as Russia made further preparations to invade and then ultimately moved into Ukraine. In an already uncertain environment, traders and investors sold first before more clarity on the situation surfaced later in the week.
Even though the equity market’s January lows were breached, Thursday’s major reversal higher and Friday’s follow-through buying pushed benchmarks back above key levels, which was an encouraging development for bulls.
Buyers came in strong after the sanctions imposed on Russia for its attack of its non-North Atlantic Treaty Organization (NATO) member neighbor were not as bad as feared. Specifically, there were no sanctions on Russia to export oil and gas. Sanctions of that type would have only added to mounting inflation concerns and more aggressive rate hikes, which caused investors to de-risk prior to the Russia-Ukraine tensions.
For what it is worth, buy-to-open put/call volume ratios on SPX and NDX components are clearly heading back higher. They both troughed on Feb. 11, when the SPX closed at 4,418, and the NDX closed at 14,474. If these benchmarks move back above these levels amid the current build in pessimism, it would signal longer-term buyers overwhelming shorter-term traders — the opposite of the red flag warning mentioned last week.
“The increasing number of bears, whether evident in various surveys or in the options market, have pressured stocks lower as the Fed transitions from an extremely accommodative policy. There have been various technical breakdowns from a short-term and intermediate-term perspective along the way. For a serious unwind of this negative sentiment to occur, the broad market must take out key resistance levels.”
- Monday Morning Outlook, February 22, 2022
During the past few weeks, we have observed that pessimistic sentiment among traders makes conditions ripe for a major bottom. But we have also cautioned that overhead technical levels must be taken out to pressure the bears into covering and/or move investors off the sidelines and back into equities at these depressed levels.
One survey that is showing mounting bears is the weekly survey from Investor’s Intelligence (II), whose respondents are newsletter advisors. In fact, the below graphs give you a visual on the growing pessimism in this survey, as the percentage of bears is almost higher than the percentage bulls. This has occurred only a few times in the past six years.
The first graph below calculates the bullish percentage minus the bearish percentage of respondents. As such, the blue line will move below zero when bears exceed bulls. Going back to 2016, when this occurs, it has been coincident with major buying opportunities.
Moreover, quantified data in the table below shows that when sentiment in this survey is on par with the levels that we are seeing now, the SPX, on average, outperforms its “at-any-time” historical returns over short-term and intermediate-term time frames. As the table indicates in bold, we are currently in the 20-30 percentile of “bull minus bear percentage” readings all-time, which bulls should welcome.
The risk, of course, is future readings getting even more bearish, at which point the expected outperformance is reduced, as such widespread bearishness takes more time for the market to build a base and embolden potential buyers.
If you are aggressive and the time frames above fit your holding periods, you can play the quantified results. But with benchmarks trading below key technical resistance levels still, a hedge or tighter leash than normal should be considered for bullish plays.
A technical risk, for example, is that the SPX has been trading in a down channel since November. The top rail of this channel begins this week at 4,485, just above the 4,475 level that marks double the 2020 closing low. On Friday, the trendline will be sitting at 4,450.
If selling resumes, the bottom of this rail sits at 4,033 today, and ends the week at the 4,000-millenium mark. But the SPX would first have to break below last week’s low, which was supported by its 320-day moving average, another long-term trendline that we have discussed in the past (in May 2019 it acted as support, and in March 2020 a break of this trendline led to vicious selling).
Per the chart below, it is encouraging for bulls that the SPX closed last week above 4,300, which has marked multiple lows since July. Moreover, it closed back above its 260-day moving average, which is approximately one year’s worth of trading.
But technical risks remain amid the rebound, per the discussion above and the chart below. Further technical improvement must occur before bears finally feel pressured to give up.
Finally, it was noticeable last week that after the Cboe Volatility Index (VIX — 27.59) moved up near the January high on an intraday basis, it closed Thursday and Friday below the 33.20-34.44 area, which is double last year’s close and this year's closing low. A close above this area would wave another cautionary flag.
Todd Salamone is Schaeffer's Senior V.P. of Research
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