S&P 500 up 17.4% in just seven days

I was subjected to considerable incoming flak over my recent columns, in which I predicted the extreme oversold condition of the market below its long-term 200-day MA, and the record level of investor fear and bearishness, indicated the market should take off into a significant bear market rally very soon.

Having been in the business for 22 years the flak was expected, reflecting the data that showed 70% of investors were extremely bearish – each one able to quote many reasons why, with the economy headed into the next Great Depression, and S&P 500 earnings declining sharply, the market could only plunge still further.

But, while the market moves in the long-term on its expectations for the economy and earnings, thus cycles back and forth between bull and bear markets, it moves in the intermediate-term by cycling between being overbought and oversold, conditions that are usually verified by investor sentiment being either very bullish (at the overbought rally tops) or very bearish (at the periodic oversold lows).

With the S&P 500 up 17.4% in just seven days, the skepticism has died down some, again confirmed by data that investor sentiment has already come down from the extreme of bearishness seen a couple of weeks ago.

For instance, the weekly poll of its members by the American Association of Individual Investors reached a record level of 70.3% bearish, only 18.9% bullish, a couple of weeks ago (March 5). My research firm considers bearishness to be extreme to the point where we need to watch for a potential upside reversal by the market, any time the poll shows more than 55% bearish and fewer than 25% bullish. As noted, the poll on March 5 showed a record 70.3% bearish. The poll on March 12 (three days after the big rally began) showed 54.5% were still bearish, which is typical.

But this week’s poll shows quite a reversal already, with only 38.3% bearish and 45.1% bullish.

Such a quick reversal in sentiment is a reason to be cautious about the staying power of the rally. In positioning our subscribers for the rally we told them we would not expect the rally to end until bullishness reached 55%, and bearishness dropped below 25%, which normally takes several months.

So sentiment will bear watching. If the market experiences a few days of profit-taking and pullback as we expect, that would likely bring back some fear and bearishness, which would be a positive as far as the rally continuing.

The second situation concerns the market’s technical situation, in which the market is at an important juncture. That can be seen in two charts I put on my free blog post last Wednesday. You will see that the first, a short-term chart, shows how the major indexes have broken out above the short-term overhead resistance at their 21-day moving averages. That is a positive. But will the rally only last until the market becomes short-term overbought above the moving average, where it will also run into a short-term trendline of resistance? Or as shown in the second chart, a long-term chart, will it continue into an intermediate-term rally of several months duration? The long-term chart shows how substantial such a rally could be, given how extremely oversold the major indexes are beneath their long-term, 200-day moving averages.

One reason to expect the latter is that, as the chart shows, the S&P 500 and other major indexes are even more oversold than they were at the oversold lows in the 2000-2002 bear market, from which significant bear market rallies were launched in that bear market. In fact, the Dow has only been this oversold beneath its 200-day MA once in the last 75 years, and that was at a low in 1930, just before the Dow launched into the 50% bear market rally that took place in the middle of the granddaddy of them all 1929-32 bear.

But investor sentiment might come into play if sentiment becomes too bullish too soon.

So while most investors are spending a lot of time and energy stressing over events that are sideshows to the market; the bonuses paid to Wall Street executives, the $trillions being thrown at the slowing economy, what the massive debt will mean to future generations, and looking for signs of improvement in economic reports; their investments (and therefore their ability to weather the catastrophes they expect) might be better served by ignoring the sideshows and focusing on what the market is telling them with its overbought/oversold conditions and investor sentiment.

Just a thought.