Rarefied Air for Stocks

What may give the market more fuel for additional gains is the condition of a couple of key sentiment indicators. CBOE put/call ratios remain very elevated despite the strong rally in the stock market since mid-July. Typically, when the stock market rallies sharply, put/call ratios will decline rather quickly. Not this time. One reason may be that put/call ratios got to record levels in May and June. Another reason may be that institutions were expecting the seasonal patterns to play out with the typical weakness in September and October. Obviously, that has not happened.

As option players unwind these bearish bets, and slowly become more bullish, long put options are sold and call options are purchased, adding fuel to the advance. The 30-day CBOE put/call ratio sits at 0.94, down from the record in June of 1.09. However, the current reading is still considered very high from an historical perspective. The 30-day put/call has generally not bottomed out until it fell to the 0.70 to 0.80 range, well below Thursday’s reading.

A look at some of the investment polls leads us to believe that the rally also has further to go. Investor’s Intelligence (II) poll of newsletter writers is showing 52.2% bulls and 30.4% bears. While there has been a large shift back to the bullish camp since June when only 35.6% of newsletter writers were bullish and over 36% were bearish, the shift probably has further to run, in our opinion. The last major peak in sentiment in this poll was in December, 2005, when bulls marginally exceeded 60% and bears fell just below 21%. Over the last decade, major peaks in the stock market have been accompanied by bullish sentiment that is 30 percentage points higher than bearish sentiment.

Sentiment on the American Association of Individual Investors (AAII) poll is less bullish than the II poll. Bullish sentiment is only 37.8% while bearish sentiment is 46.7%. The numbers in this poll can change quite rapidly but they are currently suggesting that individuals do not have a lot of belief in the markets strength. The last bullish extreme in the AAII poll occurred late 2005/early 2006 when bullish sentiment rose to 59% and bearish sentiment fell to only 16%.

The 10-year Treasury note had another tough week, with the yield finishing at 4.81%, well above the late September low of 4.56%. The 10-year yield has completed a small double bottom and has risen quickly back into a small zone of chart support between 4.72% and 4.85%. A 38.2% retracement of the decline in yields from June to September comes in at 4.82% while a 50% retracement targets the 4.9% level. Chart support becomes more substantial up between the 4.95% to 5.25% area. The daily MACD has turned bullish after getting very oversold, but the weekly MACD has not turned favorable yet as the reversal is still young.

Crude oil prices once again closed lower for the week but continued to hold support in the $57 to $58 area. There have been some positive divergences on the daily MACD and RSI charts, following a deep oversold condition towards the latter part of September. The weekly MACD is still heading lower, and it will be important in our view that weekly momentum starts to stabilize. We are also still looking for some basing/stabilization in prices before calling for an intermediate-term reversal to the upside.

One potential positive is the action of the oil stocks in light of the lack of rebound in oil prices. The S&P Energy SPDR (XLE) has jumped over 6% since late September, and it may be an indication that investors think the price of oil has bottomed out.