The main contribution of sentiment gauges is to tell you whether the market is in either a excessively bullish or bearish phase. In the past ten years I have run the 2C Sentimemeter (2CS) which is the five day running total of the daily product of VXO times the CBOE combined put/call ratio. A lower number indicates options buyers are bullish, and a higher number that they are bearish.
In the 1990's and up to 2003, tops were made when the 2CS was in the 60's. Since the bull market began in 2003, there has been a "range shift" so that it takes more bullishness to turn the market down and less bearishness to turn it back up than it did from 1996 to 2003.
A reading from 90 to 120 has always been sufficient for a low except during the 1998 crash, and 2002 and 2003 lows when readings exceeded 200.
Thus if the drop from May is a "normal" correction in a continuing bull market, we should turn up before long.
In late 2000 I started looking at a new indicator on a daily basis to see if I could improve on the slower 2CS. It evolved by spring 2001 to include an "amplified" options component plus up/down volume and breadth (up/down stocks) components in a "cocktail" of my own.
In this daily Sentiment Oscillator, under -3 and over +13 have indicated excessive bearishness and excessive bullishness respectively on a short term (days to weeks) basis.
In sentiment work there is always a danger of a "range shift" when longer term sentiment is changing. We saw that for the upside when sentiment ranges expanded upward in 2003-2004. this trapped a lot of bears who expected a resumption of the bear market when sentiment got "too" bullish on a short term basis. Instead all we got were modest corrections to the new bullish trend.
That can happen to bulls too, and it demands honesty and thoughtful observation. If this decline drags on with sentiment staying down under zero or -3, and/or a rally fails to be robust, the market may be telling us that the longer term trend has changed to down. I don't see that happening yet, but this drop is a bit deeper and quicker (momentum) than we've seen since August 2004, so it's best to be careful and to be honest with oneself.
Recent Comments