The Week Ahead: Is Bearish Sentiment High Enough?

The weakness in the Shanghai Composite spooked investors at the start of the week but they seemed to be less concerned as the week progressed since the Composite lost another 10%. It was the worst month for the Shanghai Composite in the past six years.

As the US market gapped lower to start the week the full slate of earnings reports and economic reports made many nervous. Therefore the 1.20% gain for the week in the Spyder Trust (SPY) was a pleasant surprise.

The earnings seasons has been a positive for the market though several companies did disappoint. Thomson Reuters is looking for a 0.8% gain in earnings which was considerably better than the pre-earnings estimate of a 1.2% decline.

As the market moved higher last week individual investors became more bearish according to AAII. The questions is are they bearish enough to support a broad based market rally that can move all the major averages to new all time highs?

The Markets

Fig1

In last week’s American Association of Individual Investors (AAII) survey the % of bearish individual investors jumped 15.1% to 40.7% which is well above the long term average of 30.3%. This is the highest reading since August 22, 2013 (point 1). It had spiked in April of that year with back to back readings of 48.2% and 54.5% (point 2).

These extreme readings in 2013 just corresponded to just brief interruptions in the major stock market rally of 2013. These high readings occurred while the 20 week MA was falling which confirmed that the bearish % was still in a downtrend. This was in contrast to the periods when the MA was rising in 2011 and 2012.

Fig2

In my market trend analysis I have found the bearish% to be less valuable than the bullish% which dropped last week to 21.1% which was a decline of 11.4%. This is lower than the 22.61% reading on July 2, 2015 but above the 20.04% reading from June 11, 2015. Prior to these readings the bullish% had not been below 25% since April 11, 2013 when it dropped to 19.31%.

During the market’s correction from July through early October 2011 it never dropped below the 25% level. During the equally severe 2010 correction it hit a low of 20.94% on July 8th and then 20.74% on August 26th before the market bottomed in early September.

At both the 1010 and 2011 lows the NYSE Advance/Decline line gave clear signs just days after the lows that the market’s correction was over. In 2013 the A/D line was strong throughout the year so the extreme low readings in the bullish% came within the context of an A/D line that was in a strong uptrend.

In the Market Wrap section it is evident that neither the weekly or daily A/D lines are indicating that the corrections from highs is over. The bullish sentiment is low enough to suggest that a bottom could be completed in the coming weeks.

Fig3

When the Nasdaq 100 made a new high on July 20th I pointed out (Narrow Advance Warrants Caution) that rally was the result of the gains in just a few stocks. AMZN, AAPL, MSFT , GOOG and FB make up represent 35% of the PowerShares QQQ Trust (QQQ. Therefore the new high (point 1) was giving one a distorted picture of the market.

The Nasdaq 100 A/D line actually peaked on May 18th and has been diverging since then as it has formed a series of lower highs, line c. The A/D line has moved back above its WMA but needs to move strongly above the July highs to turn positive. The OBV turned down Friday and has also formed lower highs, line e.

It was a rough month for both gold and crude oil as the gold futures had the worst month in two years. The SPDR Gold Trust (GLD) was down 6.6% for the month. The gold market tried to rally last week in line with the high level of bearish sentiment but there are no signs yet of a bottom.

It is a similar situation for crude oil where the bearish sentiment is also very high and the energy stocks continue to report very weak earnings. The nearby crude oil contract was down 8.3% in July and many have began again to lower their year-end price targets to $30 per barrel.

Both Exxon-Mobil (XOM) and Chevron (CVX) were down well over 4% on Friday and they contributed heavily to the decline in the Dow Industrials on Friday. My analysis of the energy sector does suggest that this sector could make an important low by year end. In contrast many big name Wall Street firms are quite negative on the energy stocks with some even looking for dividend cuts.

Fig4

Yields on the 10 Year T-Note dropped again last week down to 2.205% from 2.271% a week ago. The daily chart shows that the long term downtrend, line a, was broken in early June. There is next support at 2.140% with key support at 2.056%, line b. The daily MACD has been negative since June and it continues to form lower highs with no signs yet of a bottom.

The Economy

For a change the better than expected economic news this week coincided with generally higher stock prices. The revision of the 1st quarter GDP to up 0.6% from down 0.2% gave investors some hope while the advance reading of 2.3% for the 2nd quarter GDP was a bit lower than expected.

Fig5

It was a more encouraging week for the manufacturers as they have been a concern for most of the year. Durable Goods data was strong as was the Richmond Fed Manufacturing Index. Also on Friday the Chicago PMI came in at 54.7 while most economists were looking for a reading of 50. The PMI had been below 50 for several months which was a sign of weak manufacturing.

Last Tuesday the Consumer Confidence plunged to 90.0 which was well below the prior month revised reading of 99.8. The University of Michigan Consumer Sentiment Friday came in at 93.1 which was close to the mid-month reading. These gauges of consumer sentiment will be important to watch as we head into the fall months when consumer buying is generally strong.

Fig6

The Employment Cost Index (ECE) caught the markets by surprise on Friday as it dropped to 0.2% from the prior months reading of 0.7%. This reflects a decline in both wages and salaries so there are no signs yet that inflation is picking up. The ECE report pushed the dollar lower as bonds moved higher on the thoughts that the Fed may not start raising rates in September.

This week we get the Personal Income and Outlays, as well as the PMI and ISM Manufacturing Index on Monday along with Construction Spending. OnTuesday we get Factory Orders followed Wednesday by the ADP Employment Report as well as the PMI/ISM Non-Maunufactoring Index. Then on Friday we get the monthly jobs report.

Market Wrap

There were strong gains last week in the Dow utilities and Dow Transports as they were up 3.77% and 3.96% respectively. They did much better than the 0.69% gain in the Dow Industrials. The S&P 500 was up 1.16% and Friday’s sharp rally in the Russell 2000 helped it gain 1.03% for the week.

Fig7

The NYSE Composite gained 1.50% last week as the high came close to the 20 week EMA. The weekly downtrend is in the 11,060 area with further resistance at 11,170. The weekly starc+ band is at 11,370. There is short term support now at 10,750 with more important at the quarterly pivot support at 10,620 which was tested last week. This level also corresponds to the chart support at line b.

The positive weekly A/D numbers caused the A/D line to turn higher but it is still well below its declining WMA. The weekly A/D line needs to move through the downtrend, line c, to turn positive. The daily NYSE A/D line (not shown) is still in a clear downtrend.

Fig8

The Spyder Trust (SPY) dropped to test the quarterly pivot at $207.38 last Monday before turning higher. The daily starc+ band is at $212.69 with the all time high at $213.18. There is important long term support, line a, in the 205 area.

The S&P 500 A/D line closed the week just barely above its WMA but turned lower on Friday. The A/D line still has important resistance at the downtrend, line b, and then at the July high. The A/D line shows a longer term pattern of lower lows, line c. The on-balance-volume (OBV) has dropped back below its WMA and it is still well below the long term downtrend.

In addition to the strong gain in the utility average the industrials also did well but the Industrials Sector Select (XLI) is still down 3.25% for the year. Health care was up 2.28% for the week but both the financials and technology stocks managed just minor gains.

It has been a tough earnings season for individual stock holders as Twitter (TWTR) is down over 20% in the past three months. It dropped 12.45% last week while Yelp (YELP) was down 23.6%. Even the diversified Global X Social Media (ETF) was down 4% for the week but is still up over 5% for the year.

If the market corrects early this week but is then able to close the week higher it will support the case that the market is going to move higher. A lower close should keep the bullish% low and the technical studies do suggests that the market needs more time before it begins a sustainable new uptrend. I would not be an aggressive buyer until the A/D lines confirm that the correction is indeed over.

My analysis during the week can be found on both Twitter and StockTwits with my daily and weekly columns also at Trade Your Own Money.