Are stocks oversold?
As shares flounder near multimonth lows and the eurozone crisis simmers, there are indications that pessimism has gone too far.
After some impressive strength earlier this week that returned the major averages to their late May highs, the rebound rally has run out of steam. Investors clearly have a lot on their minds. On the downside, the Federal Reserve and the European Central Bank seem less than eager to deploy fresh monetary policy stimulus. On the upside, Europe appears to be cobbling together a direct bank aid package for Spain, while China's central bank just cut interest rates for the first time since 2008.
I think it's just a temporary pause in what will prove to be a short-term rebound rally. Based on hedge fund positioning and other measures of market sentiment, many investors are very worried and positioned extremely defensively. I think that sets the stage for some upside surprise before the long-term downtrend reasserts itself.
There's plenty of evidence of overly dour sentiment.
The eight-week average of the AAII bull-bear ratio has dropped to its lowest level since April 2009 just as the 2007 bear market was ending. There have been more bears than bulls for eight of the past nine weeks -- the 13th such streak in the survey's history dating to 1987.
This is a huge shift in sentiment. Earlier this year, sentiment had reached an optimistic extreme not seen since late 2010. Before that, investors hadn't been that excited since late 2005.
According to Credit Suisse analysts, the net long positioning of hedge funds serviced by their prime brokerage desk has returned to lows hit last November. Compared to the bull/bear sentiment ratio, hedge fund types are actually more concerned than retail investors are.
Mutual fund outflows have also reached a rare extreme. According to Lipper FMI data, $20 billion has been pulled out of equity mutual funds over the last three months -- a level of selling pressure often associated with at least short-term turnaround points. Recent examples include the late 2011 selloff and the early 2009 drop into the bear market low.
Options traders are freaking out too. Thursday, ISE exchange traders bought only 90 equity call options (betting on higher prices) for every 100 put options (betting on a decline). That has happened only six other times over the last five years. Most recently near the April low. Also, during last September's plunge.
And finally, as shown in the chart above, market breadth has been steadily improving as fewer and fewer stocks participate in the sell-offs. This is a sign of active bargain hunting. This behavior is commonly seen near major market lows.
Keep in mind these are all short- and medium-term indicators. The long-term picture, based on the fundamental economic outlook, is still ugly for all the reasons I've enumerated in my recent columns and blog posts. A broken labor market. A looming fiscal cliff. Increasingly ineffective monetary policy stimulus. Ongoing balance sheet deleveraging by households. Unresolved structural problems in the eurozone. A Chinese real estate bubble.
Leading indicators, from factory activity surveys to global earnings estimate revisions, are all rolling over. Until these measures change, don't view the rebound as anything other than a tradable relief rally.
I'm continuing to focus the Edge Letter Sample Portfolio on new areas of strength including semiconductor, emerging market, and precious metals positions. Recent additions include the Direxion 3x Semiconductor Bull (SOXL). For the risk averse, there is the unleveraged Market Vectors Semiconductor (SMH).
The gold and silver positions are doing well. The Market Vectors Junior Gold Miners (GDXJ) is up 11.3% since I added it on May 17.
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Market analysits remind be of my teenage daughter.... all emotion and no logic barometer.
Why? the more we all buy into contrived volatility, the more transactions... the more transactions
the more money is siphoned off by the wing-tippers. This is a worse bet than Las Vegas
Sometimes you chartists ought to take a look at the fundamentals. I disagree that stocks are oversold.
With the dollar dropping, Greece defaulting, Spain waiting in the wings, and the Iran issue far from settled, and with a budget battle in the US looming and another credit downgrade virtually guaranteed, massive money printing and the resulting inflationary effects; stocks could hardly be said to be oversold (unless you're talking about some of the few foreign countries with solid currencies). How's that for a "run on" sentence?
My point ? Take the technical's jiggly lines with a grain of salt only!
"The gold and silver positions are doing well. The Market Vectors Junior Gold Miners (GDXJ +0.29%) is up 11.3% since I added it on May 17."
What about all you've added to those positions since then? As you recommended on May 30, June 1, and June 5 right before Gold had a pretty big fall.
I guess it depends on when you added on May 17, but that wasn't the only position you talked about adding. UGLD close for May 17 was 37.26, it's 38.29 as of Friday. You said generally "the gold and silver positions are doing well"
USLV was 24.33, now 25.3.
More like, action has been choppy since then. The miners is a good bottom, but I wouldn't really say that's the result of gold movement, just being oversold and being a stock.
QE3 is not happening now. It's all but sealed. The only way they are going to do something is in the event of a 2008 type melt down. In which case, GLD will be no better off than anything else in the near/medium term. You might as well put it all in cash if you think that's happening.
In face of his testimony last week, even the "volatility" trade is not certain. There's more fear recently, which has been what's driving this small spike in Gold, but that's only part of the equation. The market assumes that in fear the central banks will fire big liquidity injections into the global financial markets.
That's not happening. So I don't see the trade here, yes fear, but that doesn't override no central bank action. In fact, no central bank action probably overpowers the fear trade.
If you believe the rally, by all means buy it. If not, hold back and see what unfolds.
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