articles when employed at schaeffer's investment research

A Look at the Ascending Treasury Yield CurveMeasuring Treasury data against a chart of the S&P 500 Index (SPX)

By Joseph W. Sunderman ([email protected])11/19/2008 10:45 AM ET

Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.us

Some of the more noteworthy developments these days (beyond the market volatility) have been Treasury yields. Here is a quote from a column titled "Current Yield: Can Uncle Sam Keep Paying the Piper?" featured in Barron's this past weekend:

"The Treasury yield curve -- from 2 to 10 years, which is how the bond market tracks it -- has rarely been steeper. The spread is over 250 basis points (2.5 percentage points), a level matched in the past quarter-century only in 2002 and 1992, at the trough of economic cycles."

Below is a graphic of the difference between the 10-Year Treasury Bond and the 2-Year Treasury Note (blue line). Along with this spread, we have a chart of the S&P 500 Index (SPX).

It should be noted that the steepened yield curve "reflects anticipation of economic recovery" (according to the aforementioned Barron's article). As seen by the chart, when the Treasury spread gets to 2.5 percentage points (or 250 basis points), the SPX has been able to find some kind of bullish traction. This is not to say that the initial move over 2.5 indicates a bullish signal in short order, but it does provide (hopefully) an encouraging sign that the economy may see a turnaround in the latter half of next year.

http://www.schaeffersresearch.com/plus/archive_commentary.aspx?ID=89255#discussion

http://www.schaeffersresearch.com/commentary/emailfriend.aspx?id=89255&type=obs

http://www.schaeffersresearch.com/plus/archive_commentary.aspx?ID=89255

http://www.schaeffersresearch.com/commentary/rss.aspx

http://add.my.yahoo.com/rss?url=http://www.schaeffersresearch.com/rss/observations.xml

http://del.icio.us/post

From Main Street to Wall Street, Bearish Bets Build on the Retail Space

Sentiment is negative toward retailers across the board as we enter the holiday shopping season

By Joseph W. Sunderman ([email protected])12/4/2008 11:50 AM ET


With many retailers reporting their November sales today, sentiment toward this group can only be described as skeptical. From Main Street consumers to Wall Street options players and brokerage houses, there is unified solidarity when it comes to being bearish on retailers.

In today's Wall Street Journal article, "Holiday Shoppers Lured Only by Big Bargains," the author states that only deep discounts and promotions are keeping many consumers spending. Furthermore, "Americans are shopping, but only if the bargains are right. That puts retailers in a no-win situation for the duration of the Christmas season: They must continue aggressive discounts to move as much of their merchandise as possible, sacrificing profits."

This consumer sentiment is being interpreted bearishly by our various sector sentiment measures. Both brokerage houses and option players believe that the retailing sector is ripe for more underperformance.

Looking at brokerage ratings on the sector, one can see how the percentage of "buy" ratings (out of the total number of ratings) has declined sharply over the past year, and now stands at multi-year lows. The current percentage of "buy" ratings stands at 33.67%. Only real estate, banks, and savings & loans have lower "buy" percentages than the retail space.







Option players maintain the same downbeat sentiment as brokerage firms. Below is a chart of the aggregate put/call open interest ratio for the retail sector, along with a chart of the S&P Retail Index (RLX). The current ratio stands at 0.926, and averaged a reading of 0.93 throughout November and into the first few days of December.

Looking at seasonal activity of the aggregate put/call open interest ratio of the retail space during the last few years, we see the current readings are much higher than usual heading into the final weeks of the holiday shopping season. From 2004 through 2007, the put/call ratios for similar time periods averaged between 0.73 and 0.81. The current readings are 15% to 27% higher than those taken in the past few years.

Joseph W. Sunderman, as VP of Financial Market Analytics, oversees a team of Quantitative Analysts who are responsible for managing the proprietary/non-proprietary databases and supporting the firm's traders with filters, screens, and ad hoc studies. He was ranked by Bridge Information Systems as one of the top 10 market analysts for 3 straight years for his commentary and stock picks found in Schaeffer's Daily Bulletin. Joe has been published in the Market Pulse Journal and Chartpoint, and his market comments have been printed in USA Today, The Wall Street Journal, Barron's, Investor's Business Daily, Dow Jones Newswire, and Reuters.

<

-Joseph W. Sunderman ([email protected])

Unusual (Buy-To-Open) Option Activity Ahead of This Week's Earnings

A look at ISE option activity on Sears Holding (SHLD), Toll Brothers (TOL), Marvell Technology (MRVL), and Novell

(NOVL)By Joseph W. Sunderman ([email protected])12/1/2008 12:45 PM ET


Approximately 70 companies are expected to report quarterly earnings this week, as we have some earnings stragglers still announcing. In today's commentary, we look at 4 stocks that have unusual buy-to-open option activity with data used from the International Securities Exchange (ISE). This data is rather unique, as it looks at only option activity of buy-to-open variety, while excluding sell-to-open, sell-to-close, and buy-to-close activity. This is a more refined look at put/call volume ratios.

In the table, we highlight stocks that have a 10-Day Put/Call ratio average in the 80th percentile or higher (in green). In other words, their ratios are higher than 80% of the past year's worth of ratios. On the other hand, we also draw attention to those stocks with 10-Day Put/Call ratio averages in the 20th percentile or lower (in red). More specifically, these ratios are lower than 20% of the ratios for the past year.

Per the table below, the 4 stocks we focus on in this commentary have an unusually high 10-day average of their ISEE put/call (or call/put) ratios. Thus, we are seeing option speculators who are positioning themselves very bearishly ahead of the earnings event.

The ratios on Sears Holding (SHLD: sentiment, chart, options) , Toll Brothers (TOL: sentiment, chart, options) , Marvell Technology (MRVL: sentiment, chart, options) , and Novell (NOVL: sentiment, chart, options) are very high (ranging between 87% and 98%), which are signs of pessimism. On the other hand, Pilgrim's Pride (PPC: sentiment, chart, options) and OmniVision Technologies (OVTI: sentiment, chart, options) (among others) have put/call ratios that are showing optimism (ranging between 2.84% and 10.08%).







http://www.schaeffersresearch.com/streetools/sentiment_brief.aspx?ticker=SHLD

http://www.schaeffersresearch.com/streetools/sentiment_brief.aspx?ticker=TOL

http://www.schaeffersresearch.com/streetools/sentiment_brief.aspx?ticker=MRVL

http://www.schaeffersresearch.com/streetools/sentiment_brief.aspx?ticker=NOVL

http://www.schaeffersresearch.com/streetools/sentiment_brief.aspx?ticker=PPC

http://www.schaeffersresearch.com/streetools/sentiment_brief.aspx?ticker=OVTI

Finally, each table below provides the price performance of the stock days, weeks, and months following the report announcement.

Highlighted green cells are the sessions that are positive following the earnings announcement. The red highlighted cells are when the stock performance has been negative following the period after the announcement.

At the very bottom of each table, one can see the averages for each of the periods following the earnings announcement. Readers can use these tables and historical performance results to trade around these stocks as they approach their individual earnings announcements.

Joseph W. Sunderman, as VP of Financial Market Analytics, oversees a team of Quantitative Analysts who are responsible for managing the proprietary/non-proprietary databases and supporting the firm's Trader with filters, screens, and ad-hoc studies. He was ranked by Bridge Information Systems as one of the top 10 market analysts for three straight years for his commentary and stock picks found in Schaeffer's Daily Bulletin. Joe has been published

in the Market Pulse Journal and Chartpoint and his market comments have been printed in the USA Today, Wall Street Journal, Barron's, Investor's Business Daily, Dow Jones News Wire, and Reuters.

A Look at U.S. Analyst Coverage on Equities

Examining changes in analysts rankings over various market conditionsBy Joseph W. Sunderman and Robert Becks11/18/2008 1:21 PM ET


In a recent Financial Times article published on Monday ("US analysts least bearish among global peers"), there was some interesting points that were made in regards to how U.S. brokerage analysts are positioned in this challenging bear market. More specifically, U.S. analysts "remain markedly more bullish on stocks than peers elsewhere."

Below is a graph of U.S. analyst "buy" (green line), "sell" (red line), and "hold" (black line) ratings since 1982. Along with the ratings, we include the S&P 500 (SPX) closing price (blue line).







Click here to see the enlarged image

Standing out from this graph is the fact that analysts have not significantly changed their posture during the past several months. Despite the S&P 500 Index (SPX) shedding more than 40% on a year-to-date basis, the percentage of "buy" ratings has been fairly steady.

More specifically, "buy" ratings have trickled lower during the last year or so from a high of 47.9% (October 7, 2007) to a current reading of 45.4%. Compare that to the drop in analyst ratings that occurred after the June 2002 "buy" ratings peak at 72%. Analysts were pretty much coincidental to market action then, but largely "missed" the rally from '03-'07 and appear to be badly missing this downfall.

One area that analysts have shown improvements has been in the percentage of "sell" ratings. Since March 2007, "sell" percentages have steadily risen.

According to Dirk Van Dijk of Zacks Research, "earnings expectations are collapsing for both the fourth quarter and 2009." Thus, it will be noteworthy to see if the declines in earnings expectations will lead to future downgrades on U.S. equities in the coming months.

<-Joseph W. Sunderman and Robert Becks

ISE Buy-To-Open Call/Put Ratio Hits Multi-Month Low

Are options traders on the ISE finally accepting the bearish trend in the equities market?By Joseph Sunderman ([email protected])11/18/2008 11:50 AM ET


After several weeks of weak price action in the broad-market indexes, signs are finally surfacing that option speculators are beginning to believe in the downtrend.

At Schaeffer's, we closely watch the equity-only call/put volume ratios from the International Securities Exchange (ISE). These ratios are buy-to-open option positions, and the data is rather unique, as it only looks at option activity of buy-to-open variety while excluding sell-to-open, sell-to-close, and buy-to-close activity. This is a more refined look at put/call volume ratios.







Although the market is in the grips of a bear hug, option speculators have been rather complacent of late. In this particular case, we have seen very few ISE equity-only buy-to-open call/put ratios (*100) that have dipped below 100. This kind of positioning from option players has been perplexing and disconcerting from a sentiment perspective. Given that the S&P 500 Index (SPX) has lost over 40% on a year-to-date basis, it's surprising to see option players having a call (optimistic) bias.

In Monday's trading, we saw a small shift in the activity of options speculators. Yesterday saw the first ISE equity-only buy-to-open call/put ratio register a reading of 96, marking the first reading below 100 since March 19, 2008 (97). In fact, there were a cluster of signals (4) in March ranging between 66 and 99. The only other date when this ratio dipped below 100 was January 17, 2008. Thus, yesterday's drop is only the sixth occurrence of ISE equity-only buy-to-open call/put ratio falling below 100.

Going forward, we would like to see multiple readings below 100 amid a stabilizing market backdrop. This would indicate that option players are finally giving into this bearish trend and are no longer trying to pick a market bottom.

In drilling down on individual equities with a bearish put bias, the following names stood out: Harley-Davidson (HOG), Atmel (ATML), Century Aluminum (CENX), Walt Disney (DIS), Simon Property Group (SPG), and Qualcomm (QCOM).

Enjoy my commentary? Now, you can get it sent directly to your inbox. Simply click here to sign in, select "author" from the first box, determine how often you'd like to be alerted, and enter "Joseph Sunderman" into the third box. Easy as 1, 2, 3!

-Joseph Sunderman ([email protected])

Member of the financial media? Click here.

Analyzing 26 Sectors' Performances During Recent Broad-Market Rallies

After yesterday's eleventh-hour rally, we took a look at some sectors' reactions to recent surges higherBy Joseph Sunderman ([email protected])11/14/2008 11:20 AM ET


For the third time during the past month, the S&P 500 Index (SPX) gained at least 6% in a single session yesterday. Although the 6.92% gain on the day marked the smallest of the 3 rallies, it's worth noting that the index surged 11% higher off its intraday lows. The other 2 dates where the bulls stampeded the market were October 13 (11.58% gain) and October 28 (10.79% gain).

In the wake of yesterday's vault higher, we decided to dissect 26 different sectors and their performances during the aforementioned 3 rallies from the past month. The results are displayed in the table below, with the various sectors listed from best to worst single-day performance:







As you can see from the chart above, the groups that performed the best (in terms of rank against peers) were the PHLX Oil Service Sector Index (OSX), S&P Insurance Index (IUX), AMEX Airline Index (XAL), CBOE S&P Chemicals Index (CEX), and AMEX Securities Broker/Dealer Index (XBD).

From an under performance perspective, the groups that performed the worst (in terms of rank against peers) were the Wireless HOLDRs Trust (WMH), Powershares Retail (PMR), Select Sector SPDR Consumer Discretionary (XLY), Select SPDR Healthcare (XLY), and AMEX Computer Technology (XCI).

In conclusion, it may be helpful for traders to see which sectors have outperformed or underperformed during these rallies. In looking at the trends, one can position themselves appropriately (through paired trades) when a snapback rally is forthcoming.

Enjoy my commentary? Now, you can get it sent directly to your inbox. Simply click here to sign in, select "author" from the first box, determine how often you'd like to be alerted, and enter "Joseph Sunderman" into the third box. Easy as 1, 2, 3!



Small Traders Going Bullish on S&P 500 Index Futures

Examining the Commitment of Traders report for small tradersBy Joseph Sunderman ([email protected])11/11/2008 1:30 PM ET


In our weekly review of net positions of Commitment of Traders (COT), we noticed unusual positioning by small traders on S&P 500 Index (SPX) futures. This column looks at the quick transitioning of small traders from a very net short position to now a positive long position.

On a weekly basis, the U.S. Commodity Futures Trading Commission (CTFC) releases data known as the Commitment of Traders. COT reports provide a breakdown of each Tuesday's open interest for market reports in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC. The report is broken down by Non-Commercial (a.k.a large speculators), Commercials (a.k.a. large commercial traders), and Non Reportable (a.k.a. small traders and speculators). In this commentary, we focus on the last group – small traders and speculators.

Below is a graph of small traders net positions since November 2003. What we've seen in the past week are small trader net positions going from -24,637 to 9,208 for a net change of 33,845. Looking at data since 1986, this is the largest 1-week change that we have witnessed in our database.







Historically, there are not many references from past data to draw conclusions from the data. We have seen only 3 occurrences when small trader net positions went from a negative net positions to a positive one greater than 9,000 contracts. These occurred in November 2006, September 2008, and May 2008. On average (over the 3 previous signals) the SPX gained 1.77% during the next 4-week time frame.



Jobless Claims – Indicator Du Jour

Examining the jobless claims indicatorBy Joseph Sunderman10/30/2008 12:02 PM ET


If you catch any CNBC during the day, it seems that a weekly economic indicator that is getting more press of late has been jobless claims. Jobless claims is reported weekly (on Thursdays) and is simply shows the number of first-time (or initial) filings for state jobless claims nationwide. This data is seasonally adjusted, as hiring can vary throughout the year (i.e. temporary work around the holiday season).

Since this figure can vary week to week, many use a moving average to measure the trend in this economic indicator. Today, the figure was 479,000 initial jobless claims, which was unchanged from the previous week and above the average for the 2001 recession.

Historically, this weekly indicator gets very little attention, while its monthly "cousin" – nonfarm payrolls - seems to get all the limelight the first Friday of each month. The initial jobless claims indicator grows in importance when the economy is going through a period of transition or turning point, as we are experiencing currently.

The concern at this point is that the troubles in the credit markets are now spilling over to the "real" economy, which impacts corporations, small businesses, and in turn, the U.S. workforce. As seen by the accompanying graphic (shaded gray areas are those periods when the U.S. was in a recession), there is a close relationship between jobless claims and the S&P 500 Index (SPX). When initial jobless claims are growing at a quick rate and sit at a high level (450K+), the SPX tends to be particularly weak. Thus, we recommend continuing to watch this weekly figure, as it provides insight into how the real economy is being impacted by the credit crunch.







Click here to see the enlarged image -Joseph Sunderman


Buyer Strike or Simply Not Enough Sideline Money?

Where and who are the buyers in this current market?By Joseph W. Sunderman ([email protected])10/23/2008 4:03 PM ET


With the market continuing to show volatility and unrest, the question that we have on our trading floor is where and who are the buyers? Is there a buyer strike or not enough money on the sidelines that is not being put into use? This commentary tries to answer these questions.

A recent article from the Financial Times (10/21/08) stated:







But traders, many of whom have been burned badly by the turmoil of the past 18 months, are reluctant to engage in the bargain-hunting buying spree some have predicted. Evidence of this reticence can be found in the hedge fund sector in which managers have placed $600bn in cash, says Citigroup.

According to Hedge Fund Research, total industry assets are around $1.72 trillion. Thus, based on the figure from the article, the percentage of assets in cash is approximately 35% - a very high figure.

The Financial Times article also commented that the largest hedge funds (SAC Capital, Paulson & Co., and Millennium Partners) have cut back on their trading and have shifted funds to cash.

This trend is alarming, as hedge funds have been a significant influence for the day-to-day liquidity during the past several years. Their very absence could be a reason for the volatility and disjointed markets we have witnessed. It seems that there is a buyer strike from hedge funds, as they ride this storm out on the sidelines.

It should be noted that the other significant institutional player to the equity markets are long-only stock mutual funds. One of the concerns from this group is the lack of cash that it has been holding for the last several years. As seen by the accompanying graph, cash levels have ranged between the 3.5% to 4.5% range since early 2003. Such low cash levels raise two problems. First, when met with redemptions in times of market turmoil, equities (the most liquid investment vehicle) need to be sold, as there is not enough cash on hand to meet redemptions. Second, since cash levels are so depressed, fund managers have little capital to invest when stock prices are trading at a discount.

Finally, another group that comes to the rescue of the market in times of trouble is corporations. Corporate stock buybacks are typically strong during periods when equity prices trade well off their peaks. Corporations demonstrate the confidence in their shares by buying back stock at discounted prices. It seems given that "cash is king" and that credit markets are far from optimally functioning, corporate stock buybacks may not be in the picture at this point.

-Joseph W. Sunderman ([email protected])


What the 5-Week Options Expiration Cycle Means for Stocks

Examining the effects of 5-week expiration cycles on the S&P 500 IndexBy Joe Sunderman and Rocky White10/17/2008 9:35 AM ET


The October series of options expires today after the close, which means next week will begin a new expiration cycle. Most expiration cycles are 4 weeks; however, sometimes expirations can be 5 weeks. Next week heralds the start of one of these 5-week cycles. Historically, we've found the beginning week of 5-week cycles to be bearish for the market.

Below is a table that shows weekly return data for the S&P 500 Index (SPX) since 2006. Notice that for all weeks since 2006, we saw an average return of -0.19%. While the average is negative, most returns were positive (52%). Now, look at weekly returns of the first week in a 5-week expiration cycle. The average return was significantly worse, and furthermore, only 27% of them were positive.

Below is a table showing returns for the S&P 500 for the first week of a 5-week expiration cycle. Only 3 of the 11 occurrences were positive. The last 5-week cycle was the September expiration. The first week of that cycle ended on August 22, and returned -0.46%. The last time one of these weeks was positive was February of this year, in which the week returned 0.23%.







Implications: As the numbers indicate, it appears that the market may see some weakness as we head into the first week of the upcoming 5-week expiration cycle. The reason behind the pressure is due to the added emphasis on index put accumulation. As these puts are added on the newly front-month series, hedging by market makers (in the form of short selling) could create headwinds for trading in the coming week. Additionally, given that there is more time between expirations than usual, deltas are higher on the front-month options, which will require more hedging than a 4-week cycle.

<-Joe Sunderman and Rocky White

Is This Volatility the New Wall Street?

Dissecting the recent intraday swings that have gripped the marketBy Joe Sunderman ([email protected])10/17/2008 9:20 AM ET


Welcome to the Tower of Terror. Unfortunately, this is not a themed roller-coaster ride at Disney, but one heck of a thriller ride on Wall Street. Hope you packed your 6-pack of Pepto Bismol and Dramamine, because it has been a volatile ride the last couple of weeks.







The intraday swings that have gripped the markets have been nothing short of astounding. Historically, this kind of volatility from intraday lows to intraday highs is nothing particularly unusual for the market. It is rare, but not as infrequent as what may be perceived.

As of Wednesday's close, we've seen 9 out of the last 10 sessions where the absolute value of the difference between the intraday low and intraday high on the S&P 500 Index (SPX) was 1%. We have seen such volatility in past markets:

January 2003 October 2002 October – November 1987 October 1974 December 1973 June 1970 July 1950

Thus, we are witnessing a fairly consistent and "natural" pattern of volatility that is associated with critical periods in stock-market history.

Why is this occurring? There are several reasons.

First, there is a great deal of uncertainty regarding the actions of the Federal Reserve, U.S. government, and world central banks to stave off a deep recession and stem the worst financial crisis in nearly 80 years.

Second, the credit markets - which have been the focus for the last several weeks since Lehman went bankrupt - are still not functioning to the degree that we have seen in the past. Thus, the lifeblood of this economy (credit) is still far from optimal levels.

Third, hedge-fund money is probably the biggest influence on an intraday basis. Some hedge funds are probably liquidating due to the need to meet redemptions, while other hedge funds are seeking to take advantage of the volatility. Thus, you can get wild swings.

In conclusion, the volatility will likely remain high until some of the uncertainty dissipates. This will first come from credit markets becoming more stable. Second, hedge-fund redemptions and deleveraging will need to slow down, which is an unknown variable. As news of failing hedge funds is greeted with positive market-price action, this will be a sign that the Great Hedge Fund Unwind (credit to Paul Kedrosky for that title) is nearing an end. Further stabilization will come from economic data, business confidence, housing, and other reports showing signs of bottoming. This will only act as a confirmation that a floor has been put in on the market. However, all of this will take some time.

-Joe Sunderman ([email protected])


Credit Markets Could Use Some Global Warming

Examining 3 indicators that could give insight into the frozen credit market

By Joseph Sunderman10/15/2008 3:28 PM ET


For the past couple of weeks, investors have been hearing how the credit markets are frozen. As such, we have the tail of the credit markets wagging the dog of the stock market. In this commentary, we will look at what it means that the credit markets are frozen, while examining the indicators one should track to measure whether or not any thawing is occurring.

The Frozen Tundra

First, a frozen credit market means that credit has become very difficult to obtain. Lending practices have become very restrictive and conservative, as there is less of a propensity of financial institutions to allow corporations, small businesses, and consumers to borrow money. Lenders are nervous to extend credit due to economic conditions (i.e. housing crisis, bankrupt institutions, etc.) and the fear of not receiving the capital and interest-rate payments in lieu of the loan.

A fine-tuned, and well-oiled economy would work similar to what we have seen in Visa Check Card commercials. This smooth economic operation can quickly come to a stand still when credit (the lubricant of this economy) suddenly becomes sparse or unavailable. A tell-tale sign of how bad the credit situation has become was revealed when General Electric (GE) had to borrow capital from Warren Buffet in exchange for 10% annual dividends on the $3 billion in preferred shares he purchased.

Signs of Melting?

There are a handful of indicators that investors can track to determine whether credit markets are freeing up:

The London Interbank Offered Rate (LIBOR) is the rate which banks charge each other to borrow money. Below is a graph of the USD 3-Month LIBOR from Bloomberg.com since 2004. Since September, the LIBOR has skyrocketed from 2.81% to 4.75%. In the past 5 years, the LIBOR has never expereinced such a quick rate of change.







The TED spread measures the difference between what banks pay to borrow from each other for 3 months and what the Treasury pays. According to data from Bloomberg.com, the TED spread has increased from 1.13% to 4.56% since early September. Like the LIBOR, the TED spread has made an unusually large jump in a very short-time frame during the past few weeks.

Finally, the spread between the 5-Year Swap Rate and the 5-Year Treasury Bond Yield is a measure I track and comment on in our weekly Monday Morning Outlook. The swap spread measures the risk-free borrowing rate (5-Year Treasury) and the rate at which the market expects inter-bank borrowing (swap rate) to occur in the future. Simply, the higher the swap spread, the more perceived credit risk for banks. By graphing the data (as accompanying chart), one can see periods when the credit markets were under stress, as swap spreads expanded and concerns over inter-bank loans heightened. As of Friday, October 10, this figure stood at 1.21 – near the highest levels in years.

All 3 of these measures show that the credit markets are under duress. It has become very expensive for banks to borrow (and lend) money to other institutions. Thus, we have a significant crimp in the credit life line for the economy. During the past couple of sessions, we have seen some ever so slight improvements in these indicators, but we are still near the highs. It will be important to watch these indicators in order to know whether or not the actions taken by central banks and governments are making an impact on the credit markets. There will be more stability in world equity markets when the credit market situation stabilizes. Until then, we will still have bumps in the road.

Commitment of Traders: Large Speculators Backing Up the Truck on S&P 500 Futures

Large Speculators jumping back into the marketBy Joseph Sunderman ([email protected])10/14/2008 1:18 PM ET








Beep...beep...beep... Do you hear that sound of the truck backing up? Yes, that is the sound of large speculators loading up on S&P 500 Index Futures.

On a weekly basis, the U.S. Commodity Futures Trading Commission (CFTC) releases data known as the Commitment of Traders (COT). COT reports provide a breakdown of each Tuesday's open interest for market reports in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC. The report is broken down by Non-Commercial (a.k.a large speculators), Commercials (a.k.a. large commercial traders), and Non Reportable (a.k.a. small traders and speculators).

Below is a graphic of net positions (long minus short) for large speculators (red line) along with the price action of the S&P 500 Index (SPX) since 1994. Most noteworthy is the fact that large speculators currently have the largest long exposure of our data set (going back to 1986)! Currently, net positions stand at 58,898 for large speculators. This eclipses the previous high-water mark of 41,485 (November 2006) by 42%.

Due to the fact that there has been no data point this high, it is difficult to draw conclusive implications. Looking at previous spikes (that were not as high) in large speculator net positions, the market has seen a tendency to bounce for a few weeks following such positioning. Any bullish tailwinds at this point would be welcomed.

<-Joseph Sunderman ([email protected])


ProShares UltraShort ETFs Pointing to Bottom?

Examining growing trading volume on the

ProShares UltraShort ETFsBy Joseph Sunderman ([email protected])10/13/2008 11:35 AM ET


In this age of exchange-traded funds (ETF), we have seen a myriad of new and exciting instruments introduced for investors to diversify their individual portfolios. During the past few years, ProShares has developed several ETFs that allow individual investors to gain exposure to the major market indexes. Additionally, ProShares has created ETFs that allow investors to hedge their portfolio with Short Proshares and UltraShort ProShares. The Short Proshares are designed to go up when their underlying indexes go down (and vice versa). Furthermore, the UltraShort ProShares are ETFs designed to double the daily performance of their underlying indexes.

These instruments are not only useful for individual investors to hedge against a bear market, but these ETFs can be useful from a sentiment perspective. By measuring the volume of the UltraShort ProShares, we can gauge the current temperament of investors through these hedging vehicles.

In the accompanying graphic, we have cumulative volume (in pink) for the 6 UltraShort ETFs – UltraShort QQQQ (QID), UltraShort Dow30 (DXD), UltraShort S&P500 (SDS), UltraShort MidCap400 (MZZ), UltraShort SmallCap600 (SDD), and UltraShort Russell2000 (TWM). Also included in the graph is the price action for the S&P 500 Index (SPX).







During the past couple of years, we have seen significant spikes in the UltraShort cumulative volume associated with market bottoms (per each date). In light of the recent decline, the UltraShort cumulative volume on October 6th was approximately 30% higher than any previous peak for the past 2 years. Thus, we are seeing signs of capitulation, as investors look for any instrument to hedge (or speculate) in this market downturn.

Market Implications of the Federal Reserve Rate Cut

The S&P 500 Index's (SPX) reaction to rate cuts during the past 2 yearsBy Joe Sunderman ([email protected])10/8/2008 10:30 AM ET








In a response to the global market turmoil, the U.S. Federal Reserve cut its federal funds lending rate by half a percentage point to 1.5%. This brief commentary shows how the S&P 500 Index (SPX) has reacted to rate cuts over the past 2 years.

The table below reflects the dates of the rate cuts, the depth of each rate cut (in basis points), and the returns of the SPX from the day of to 20 days following the rate cut. At the bottom of the table, we tabulated the average returns and the winning percentage (percent positive after X days).

Standing out from this data is the fact that the 4 rate cuts in 2008 have been well received by the market, with implications of bullish tailwinds during the next month. We can only hope for the market to stabilize from the recent treacherous conditions, as central banks across the globe make coordinated efforts.

-Joe Sunderman ([email protected])


Not Enough Pessimism from a Major Sentiment Poll?

What does Investors Intelligence data tell us about the current market?By Joseph W. Sunderman ([email protected])10/7/2008 3:34 PM ET








Investors Intelligence (located in New Rochelle, New York) is the oldest and most well-known sentiment survey. The survey began in 1962 and reflects the opinions and market postures of newsletter editors. Given the breadth of data that this survey provides, analysts can measure the relative sentiment of today's market in comparison to past market declines.

In the table below, one can see how bullish newsletter editors were during 20% market declines during the past 30+ years, as measured by Investors Intelligence. The table reflects the period of the market decline, the average bullish percentage reading during the period, and the high and low bullish percentage reading during the pullback

Looking at the table, the bullish sentiment, as measured by average, high, and low are fairly in line with past market pullbacks of this magnitude.

This is not to say that present bullish percentage readings are justifying a market bottom. Since late July, bullish percentages have ranged between 31.8% and 40.7%. More noteworthy is the fact that the market has been setting new lows while the bullish percentage has stayed in the range of the mid to upper 30's. Last week's Investors Intelligence reading came in at 33.7% bullish – still well above the 27.4% low on July 9th.

A new Investors Intelligence number will be posted Wednesday. Given the market's volatility this week, we hope to see a dip below the 30 level to reflect more of the pessimism necessary for a market bottom.

<-Joseph W. Sunderman ([email protected])

Member of the financial media? Click here

A Look Ahead at Non-Farm Payrolls

A look at the S&P 500 Index's (SPX) reaction to non-farm payrollsBy Joseph W. Sunderman ([email protected])10/2/2008 1:53 PM ET








The August Non-Farm Payroll release (on September 5th) saw a loss of 84,000 jobs, as the unemployment rate rose from 5.7% to 6.1%. On this news, the S&P 500 Index (SPX) rallied 0.44%. U.S. Non-Farm Payrolls will be released Friday morning at 8:30 EST.

In the table below, we show the reactions of the SPX for each of the Non-Farm Payroll releases since 2007. Standing out from the table is the fact that the reaction in 2008 5 days following the release has been best qualified as "rough." The average return after 5 days following the announcement has been -1.09. Additionally, the market has been consistently negative with only 22% (2 out of 9) positive after 5 days.

The one caveat to this trend is the impending decision/vote of the revised federal bailout plan in the U.S. House of Representatives. This vote could influence the market, rather than the Non-Farm Payroll release in days ahead.

<-Joseph W. Sunderman ([email protected])

Did the SEC's Short-Selling Ban Really Limit Volatility?

Examining the effects of the short ban on volatility, liquidity, and bid-ask spreadsBy Joe Sunderman10/2/2008 11:15 AM ET


On September 19, 2008, the U.S. Securities and Exchange Commission (SEC) banned short selling on about 800 stocks. This move was done in an attempt to calm the markets in the midst of the current credit crisis. The ban was originally supposed to end yesterday, but it has been extended. Below, we take a look to see what effects, if any, that this short-selling ban has had on the relevant stocks.

Below is a graph that shows the returns of the stocks included on the SEC's short-ban list since that rule was put in place. These returns were broken down by those with substantial short interest -- where short interest as a percentage of float (SI%) is greater than 8% -- and those with lesser short interest. We also include the returns of the broader market via the S&P 500 Index (SPX).

One could argue that the ban did limit the volatility of the stocks on the no-short list. Notice in the graph how the spikes of the SPX (green line) are more exaggerated than those of short-banned stocks (red and blue lines). There did not seem to be a significant difference in the performance of highly shorted stocks when compared to stocks with less short interest.

Some argued that the short-sale ban would dry up needed liquidity in these stocks. Below, we take a look at the average volume of these stocks. We notice a big spike at the beginning of September in the volume of these stocks. (That was about the time that the government took over Fannie Mae and Freddie Mac.) The black line marks the







date that the SEC short-sale ban went into place. The average volume did fall off quite a bit immediately after the ban; however, it didn't even fall back to the normal levels seen before September.

Another measure of liquidity is to look at the bid-ask spreads on these stocks. That is what we do below. Again, the date of the ban is marked. We see the spreads on these stocks rise up at about the time of the ban, and they're extremely volatile afterwards.

In looking at various angles of the short-ban rule, it appears that volatility decreased on these stocks, volume decreased, and the bid-ask spreads became much wider and more volatile than previously seen.

A Look at the CBOE Market Volatility Index's September Rally

Examining the S&P 500 Index's performance following large spikes in the CBOE Market Volatility Index (VIX)By Robert Becks and Joseph Sunderman10/1/2008 12:30 PM ET


"October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February." ~Mark Twain

Mark Twain was a little off, as September has proven to be a peculiarly dangerous month to speculate in stocks. Historically, September has been a challenging month for the market and the 2008 version lived up to its past. Since 1980, the month of September has lost on average of -0.80%; the only month of the year to have negative returns on average. September 2008 saw a decline of -9.08%. During the past 28 years, this ranks as the second worst September, only falling short of -11% decline in 2002.

Given the volatility we saw in September, the CBOE Market Volatility Index (VIX) saw an extraordinary percentage jump during the month. Looking at our data set since 1990, we find that the VIX jump was the highest monthly increase, soaring 91% last month.

Of the 224 calculated month-to-month VIX percentage-change readings, 23 of them were greater than 25%. After such occurrences, the market (as represented by the S&P 500 Index [SPX]) is usually positive during the next 1 to 6 months, but it has not averaged outstanding positive returns.

More notable is the fact that that market performance really improves when you consider only VIX 1-month surges of 40% or more (bottom section of table). After those readings, the market has been positive more than 75% of the time during the calculated return periods. More impressive are the fantastic SPX returns generated over the 2-, 3-, and 6-month periods following those signals. Let's hope the market responds similarly!







-Robert Becks and Joseph Sunderman


ugust Option Advisor Commentary

Examining extreme investor sentiment in the current market environmentBy Joseph Sunderman8/6/2008 8:12 AM ET


The following is a reprint of the market commentary from the August edition of the Option Advisor, published on July 24. Prices and the chart are as of the close on July 24. For more information or to subscribe to the Option Advisor, click here.

June was a particularly tough month for the equity market. The S&P 500 Index (SPX) lost 8.5% for the worst June since 1930. Unfortunately, the bleeding in June did not stop at the doorstep of July, as the market continued to suffer losses in the first half of the month.

This backdrop of weak performance has rallied the bears collectively to levels not seen in years (almost 2 decades). Bearish sentiment has gripped all investment types - from professionals to newsletter editors to individual investors. It is not hard to find a card-carrying member of the bear camp these days.

According to a Bloomberg Professional Global Confidence Index survey, sentiment in June fell to 10.3 - the lowest reading they have recorded since survey's debut in November. A Merrill Lynch survey of global fund managers has current sentiment toward equities as more negative than the period between from 2000 and 2003 (when markets were much weaker). Additional concerns from fund managers lie ahead with a net 81% of respondents confident that consensus earnings estimates are too high for the next 12 months.







As represented by Investors Intelligence poll, newsletter editors are having their own bear convention. The release of the survey on July 16th saw the bullish percentage at 27.8% and the bearish percentage at 48.9%. For those statisticians among the readers, the bearish reading is in the 95th percentile of all readings since 1990. The net difference of bulls and bears (-21.1%) was the lowest figure since December 1994.

Finally, individual investors are similarly pessimistic. The American Association of Individual Investors recorded 3 consecutive weeks of readings at or below 25% (7/3/08-7/17/08). This has not occurred since February 2003 - leading up to the war in Iraq under George W. Bush.

Amid the rally off of mid-July's lows, we have seen some encouraging developments for the bulls beyond all the negative sentiment. First, public enemy #1 - oil - has declined approximately 15% off its highs. Second, despite the second-quarter earnings being completely written off (before even being announced), the results (thus far) are not as bad as what was expected. As of July 21, positive surprises were leading disappointments by a 2.9-to-1 ratio, which is inline with recent historical norms, according to Zacks . Additionally, despite the complete debacle that is going on in the financial space, we are seeing many stocks rally upon their earnings announcement. It seems that some of the earnings negativity for the second-quarter results were not only baked in, but completely overcooked. Finally, we continue to see the federal government assist a tumultuous financial market (i.e. Bear Stearns, Fannie Mae, and Freddie Mac). This has reassured investors that the feds are not standing idly by.

Despite all the turmoil during the past 2 months, option players are being given an unbelievable opportunity. High stock volatility and low implied volatility is the ideal backdrop for option premium buyers.

Stock volatility is in the forefront of traders' minds these days. We are in the middle of the earnings season, which is a very volatile period for individual equities. Also, with the SPX only 4 to 6% off its lows, short-term volatility will likely remain high, as it seems the dust has not completely settled.

Turning our attention to implied volatility, the market's proxy for implied volatility is the CBOE Market Volatility Index (VIX). The VIX has dropped 27% since its intraday high on July 15th. The current VIX reading is lower than 67% of all the readings for the past year. Such VIX readings reflect an options market that is trading at a discount in an environment when the premiums have extra juice priced in them.

Though the environment is ripe for the premium buyer, this is not to say that "slam dunks" are plentiful. Volatility will be swift for both the bulls and the bears. Thus, it only makes sense to play both sides of the fence within a particular sector. As a guest columnist in July 9's "The Striking Price Daily" in Barron's, Bernie Schaeffer wrote about using options to mimic the strategy of long/short hedge funds. In the current climate, this paired options trade strategy (like the one in the Put Sell portfolio) offers opportunities for premium buyers. Utilizing the convexity and leverage of options in a "hedge" play within a volatile sector may help savvy investors through this trying period.

-Joseph Sunderman


June Option Advisor Commentary

Pessimism from the financial media floods the market

By Joseph Sunderman 6/4/2008 8:56 AM ET


The following is a reprint of the market commentary from the June edition of the Option Advisor, published on May 22. Prices and the chart are as of the close on May 22. For more information or to subscribe to the Option Advisor, click here.

"Are You Smarter than a Magazine Editor?" is our contrarian spin-off version of a popular FOX Broadcast television show. As I mentioned in the April Option Advisor commentary, there were 9 cover stories in popular business and news magazines that all carried a very bearish tone from January through the end of March. Like the television reruns during writers guild strike, it seems magazine editors collaborated to maintain and regurgitate the same bearish theme in April and May.

"How To Fix Wall Street," "Fixing Finance," and "The Great American Slowdown" were all cover stories from April. Despite the broad-market indexes coming well off their bottom, this past week we saw a late-to-the-party entry from a mainstream magazine, entitled "Surviving the Lean Economy." This adds up to 12 magazine covers from 7 different publications.

This bearish theme is not only reflected in the media, but is a very representative sample that is consistent with a wide swath of sentiment and fund flow measurements that we track. The following are bullet points on indicators we monitor:

Option Players: Total equity put/call open interest ratios sits near top deciles relative to the past 4 years. Meaning, option players are very nervous.

Short Interest: New York Stock Exchange (NYSE) short interest stands at 16 billion shares, or 9.9 times average daily volume (Sentimentrader.com).

Short Sellers: The percentage of weekly NYSE Short Sales to weekly total sales sits at a lofty 25.4% (highest in years).

CTA Hedge Fund: Long exposure continues to sit in the bottom decile relative to the past 5 years. (www.CarpenterAnalytix.com)

Macro Hedge Fund Managers: Only 25% expected the S&P 500 to rise in May. (Greenwich Alternative Investments).

Equity Fund Flows: According to TrimTabs.com, "Investors are extremely risk averse in first four months of 2008: $4.2 billion daily pours into bond funds, bank savings accounts, and retail money market funds as $500 million daily gets pulled from all equity funds."

Investor Polls: Sentiment polls reflect investors unwilling to move off their bearish posture.

Amid the technical context of the market, the negativity seems too pessimistic. More specifically, we are referring to the longer-term trends in the S&P 500 Index (SPX) and the CBOE Market Volatility Index (VIX). As the accompanying chart shows, after a tumultuous period in the first quarter of 2008, the 160-week moving average has held - despite of some trying drawdowns. Furthermore, the VIX break of its 40-week moving average in early April was a telltale sign of bullish tailwinds for the market. With this VIX trendline now beginning to rollover, we believe this is an encouraging sign for the bullish case.







The underpinnings are there for a market bottom - skepticism in every corner of the market, as detailed by the bullets above. However, this is not to say that there are no headwinds in the near term. We have seen a few of our very short-term natured indicators show cautionary signals. This comes from low equity put/call volume ratios, relatively low VIX readings, and challenges for the SPX at its 80-week moving average.

These short-term concerns and the aforementioned long-term bullets reflect our market stance -short-term "neutral" and long-term "bullish" posture. For investors, in the environment where hedge funds, equity fund flows, sentiment polls, media, and short sellers are in consensus agreement with the challenges ahead, contrarians should view pullbacks as potential buying opportunities.

-Joseph Sunderman


April Option Advisor Commentary

Examining the heavy bearish sentiment in the financial media

By Joseph Sunderman4/9/2008 1:14 PM ET


The following is a reprint of the market commentary from the April edition of the Option Advisor, published on March 28. Prices and the chart are as of the close on March 28. For more information or to subscribe to the Option Advisor, click here.

A common phrase that parents tell their children is "You can't judge a book by its cover." In other words, you should look deeper before judging something. This idiom can be applied to one of our classic qualitative sentiment measures - magazine cover stories. Judging by the magazine cover stories during the past few weeks, one will realize that the media has given roughly the same degree of coverage to the events roiling Wall Street as they have to every utterance from the Democratic hopefuls. In fact, during the past 2 months, approximately 9 market-related cover stories have graced the jackets of 5 major publications - all with a consistent bearish tone. From BusinessWeek to The Economist and from Fortune to Newsweek, we have seen rampant concerns regarding the stock market's volatility, looming economic recession, stifling credit market crunch, and systemic problems of Wall Street. The list below summarizes some of the recent covers related to the market.

3/31/2008 "Reluctant Revolutionary" - Special Report "The Financial Crisis"3/24/2008 - "Waking up to the Recession"3/22/2008 - "Wall Street" - (image of broken street) 2/28/2008 - "Credit on the Edge"2/18/2008 - "Now What"2/04/2008 - "Road to Recession"1/26/2008 - "It's Rough Out There"

Magazine cover stories have been important at key market bottoms throughout the past 30 years. Some of the titles are now considered classic contrarian signals - "Recession Greetings" (1974), "The Death of Equities" (1978) , "The Crash" (1987), "High Anxiety" (1990), "The Economy: Is there light at the end of the tunnel?" (1992), "How To Survive A Scary Market" (1994), "Jitters" (1996), "How Worried Should You Be?" (1998), "America's Bubble Economy" (1998), "Grin and Bear It" (1998), "Trapped: Alan Greenspan's bubble nightmare" (1999), "The Angry Market" (2002), "Whipsawed by Wall Street" (2003), and "Which Way is Wall Street?" (2006).







We have never seen such an onslaught of negative cover stories in all our years of tracking the market. There are always periods when there are 2 or 3 negative covers in a month, but nothing close to the degree we are currently seeing. The only period in recent memory where there was such a proliferation of negative magazine covers in a short time frame was in 1998. But even that period falls short of the sheer volume we are now witnessing.

How we view magazine covers can be best summarized by our 10 Days To Successful Options Trading home-study program:

"We have found mainstream magazine covers to be an interesting contrarian sentiment indicator. When a financial trend is featured on a magazine cover, the chances are that this trend is already widely known, universally accepted, and in place for a decent length of time of very significant in magnitude."

With so much media attention being given to financial market problems, does this mean all the skeletons are out of Wall Street's closet? The magazine cover indicator would suggest that some or all the worst has passed. In fact, the latest cover story of broken "Wall Street" (along with breadth and interest rate indicators) signaled to one prominent market prognosticator that we highly respect (Paul Macrae Montgomery) that it was time to turn his Intermediate Term Stock Model positive.

This is not to say that we are completely out of the woods. One indicator that tracks the skeletons in Wall Street's closet is the spread between the 5-Year Interest Rate Swap versus the 5-Year Treasury Yield. This spread measures the risk (or willingness of institutions) to engage in a swap

(two counterparty exchange of cash flows) relative to Treasury yield. When the spread is high (between 100 and 115 basis points), the credit markets are highly stressed and there is usually spillover in the equity market. This spread reached a peak of 111 following the bailing out of Bear Stearns. Since then, this spread has declined to the mid-80s. We would want to see a move back below 60 basis points, which would be a sign of a better functioning credit environment. Thus, this indicator has come well off its peak, but still has a way to go to get back in a normal range.

Turning our attention from the broad market, we see that it's not hard to find a negative cover on housing. Cover stories on housing include "How Toxic Is Your Mortgage" (9/11/2006), "Will the Housing Bust Kill The Economy" (11/13/2006), "Bonfire of the Builders" (8/13/2007), and "That Sinking Feeling" (10/15/2007). More recently, we have "Meltdown: For Housing The Worst Is To Come" (2/11/2008). As a contrarian, housing may be an area to consider a small allocation of risk capital.

On the other hand, technology has received a number of positive mentions and accolades on the magazine-cover front. Going back to the fourth quarter of 2007, "Tech is Back" (10/29/2007) led off the tech cover parade. Many of the recent covers are not sector specific within the tech group but company specific. Michael Dell was on a cover entitled "The Comeback Kid" (12/10/2007). Following that was "Google's Next Big Dream" (12/24/2007), "Company of the Year NVIDIA" (1/7/2008), "Building the Perfect Laptop" (2/25/2008), and "America's Most Admired Company. Apple is No.1!" (3/17/2008). From our contrarian perspective, we have some growing concerns in the area of tech. One may want to consider an adjustment in allocation for this overly optimistic group.

<

The January Barometer

A Study of the January Barometer's EffectivenessBy Joseph Sunderman ([email protected])2/1/2007 10:47 AM ET


BackgroundOne of the more popular and widespread indicators this time of year is the venerable January Barometer. The theory behind the January Barometer was developed by Yale Hirsch in 1972. This theory goes like this: how the S&P 500 Index (SPX) performs in the month of January, the rest of the year follows suit. For example, a positive return in







January means a positive return for the market for the rest of the year. On the flip side, a loss in January means that the market is setting up for a negative year.

The NumbersThis indicator has had a high level of accuracy from 1950 to 2000. More specifically, the January Barometer was accurate 42 out of 50 years for an accuracy percentage of 84 percent. Drilling down further and looking at only those occurrences when this indicator missed by a "wide margin," the accuracy from 1950 to 2000 is around 92 percent.

Unfortunately, the January Barometer has been losing its accuracy since 2000. During the past seven years, this indicator has been correct only four times for an accuracy percentage of 57 percent.

TakeawayJanuary 2007 was a bullish month with the SPX gaining 1.41 percent. It should be noted that the January Barometer had only three "misses" for the past 57 years when the market had a bullish January and a negative return on the full calendar year (1966, 1994, 2001). Hopefully, this is an indication of future market gains in 2007.

<-Joseph Sunderman ([email protected])

12/1/2008 Indicator of the Week: Nova/Ursa RatioBy Joe Sunderman, Vice President of Financial Market Analytics

Background: A sentiment indicator that we monitor each day is provided by the Nova and Ursa funds from the Rydex Series Trust. The Nova fund is designed to have a target beta of 1.5. In other words, using equities, stock index futures contracts, and options on those securities and futures, the fund has a target performance benchmark equal to 150% of the S&P 500 Index (SPX). Traders who invest in this fund are considered bullish on stocks. Meanwhile, the Ursa fund is designed to provide a performance inverse to that of the SPX by using a combination of short selling and options on stock index futures. Investors in this fund are considered bearish on stocks.

Data Interpretation: We can get an accurate view of the sentiment picture by comparing the amount of assets in each fund. Specifically, we divide the total adjusted assets in the Nova fund by the total adjusted assets in the Ursa fund to arrive at a Nova/Ursa ratio. A high Nova/Ursa ratio indicates an extreme amount of optimism (everyone investing in Nova – bullish fund). A low Nova/Ursa ratio indicates an extreme amount of pessimism (everyone flocking to Ursa –

bearish fund). We have frequently found that lows in the Nova/Ursa ratio precede rallies in the SPX, while peaks in sentiment will often front run a decline in the index.

Current Reading: Below is a graph of the Net Asset Value Adjusted Nova/Ursa Ratio. The current reading for this sentiment measure is 0.89, meaning the adjusted assets of the Nova Fund amount to 89% of the adjusted assets in the Ursa Fund.

Implications: Concerning us at this moment is the promptness of Rydex fund speculators moving assets from Ursa Funds (bearish fund) to Nova Funds (bullish assets). Our interpretation of the data is that fund traders are looking for a bottom too readily. As seen by the previous peaks in the data (circled areas on graph), this level of optimism (as defined by the Nova/Ursa ratio) has been ill-timed the past several months. Given that the market is "overbought" by Relative Strength Index (RSI) measures, and the Rydex herd moving into bullish funds, we recommend defensive positioning following last week's bear-market rally. As Bernie Schaeffer has mentioned in the Option Advisor commentary, "I would remain quite defensive, looking to hedge any long stock exposure with shorts or with put positions on ETFs, including the "double inverse" ETFs on such still-vulnerable sectors as energy and technology."

Background: In a late-October commentary on jobless claims, we mentioned the following point:

"The concern at this point is that the troubles in the credit markets are now spilling over to the 'real' economy, which impacts corporations, small businesses, and in turn, the U.S. workforce."

With Friday's nonfarm payroll release, the relationship between the credit crunch and the real economy is coming fully into the light. Corporations are feeling the impact, and in turn, are making adjustments to cut costs to better withstand a slowing economic backdrop.

In this section of Monday Morning Outlook, we take a look at the nonfarm payroll figures, which are released every first Friday of the month by the U.S. Department of Labor's Bureau of Labor Statistics.

How to interpret the data: The nonfarm payroll figure represents the number of jobs added or lost in the economy during the past month, but does not include those related to the farming industry. We watch this figure to gauge the strength, or weakness, of the economy. When nonfarm payrolls are growing, it means that businesses are hiring; when nonfarm payrolls are declining, it means that corporations are laying off employees. This, in turn, gives us a clue as to how many people are employed or out of work, and indicates how much money will likely be put into the economy through the purchase of goods and services.

Current reading: In this past Friday's report, nonfarm payrolls came in at -533,000, versus the consensus reading of -350,000. U.S. companies shed jobs at the fastest rate in more than 30 years, while pushing the unemployment rate to its highest level in 15 years. The last time nonfarm payrolls fell by the degree they did last month was in December 1974. Looking at nonfarm payrolls data since 1939, this is only the seventh occurrence where nonfarm payrolls have declined by 500,000 or more (in September 1945, February 1946, October 1949, July 1956, February 1958, December 1974, and now, November 2008).

Implications: Standing out from historical data of the DJIA's performance following a nonfarm-payroll decline of 500,000 or more is the fact that the first month's returns are positive, but remain below the "at any time" figure of any monthly percentage change. Meanwhile, returns outperform "at any time" in the 3-month, 4-month, and 6-month time frames, but the winning percentage begins to erode. Moreover, when looking at the standard deviation, the returns can vary greatly.

Coupled with the trend in nonfarm payrolls, a concern is the continued elevated levels of the 5-year swap versus the 5-year yield. Since the credit crunch has been a significant factor in this economic slowdown and rising nonfarm payrolls, the crunch still has some bite left in it. This will likely continue to weigh on the economy, employment figures, and the market in general.

Indicator of the Week: Nova/Ursa RatioBy Joe Sunderman, Vice President of Financial Market Analytics

Background: A sentiment indicator that we monitor each day is provided by the Nova and Ursa funds from the Rydex Series Trust. The Nova fund is designed to have a target beta of 1.5. In other words, using equities, stock index futures contracts, and options on those securities and futures, the fund has a target performance benchmark equal to 150% of the S&P 500 Index (SPX). Traders who invest in this fund are considered bullish on stocks.

Meanwhile, the Ursa fund is designed to provide a performance inverse to that of the SPX by using a combination of short selling and options on stock index futures. Investors in this fund are considered bearish on stocks.

Data Interpretation: We can get an accurate view of the sentiment picture by comparing the amount of assets in each fund. Specifically, we divide the total adjusted assets in the Nova fund by the total adjusted assets in the Ursa fund to arrive at a Nova/Ursa ratio. A high Nova/Ursa ratio indicates an extreme amount of optimism (everyone investing in Nova – bullish fund). A low Nova/Ursa ratio indicates an extreme amount of pessimism (everyone flocking to Ursa – bearish fund). We have frequently found that lows in the Nova/Ursa ratio precede rallies in the SPX, while peaks in sentiment will often front run a decline in the index.

Current Reading: Below is a graph of the Net Asset Value Adjusted Nova/Ursa Ratio. The current reading for this sentiment measure is 0.89, meaning the adjusted assets of the Nova Fund amount to 89% of the adjusted assets in the Ursa Fund.

Implications: Concerning us at this moment is the promptness of Rydex fund speculators moving assets from Ursa Funds (bearish fund) to Nova Funds (bullish assets). Our interpretation of the data is that fund traders are looking for a bottom too readily. As seen by the previous peaks in the data (circled areas on graph), this level of optimism (as defined by the Nova/Ursa ratio) has been ill-timed the past several months. Given that the market is "overbought" by Relative Strength Index (RSI) measures, and the Rydex herd moving into bullish funds, we recommend defensive positioning following last week's bear-market rally. As Bernie Schaeffer has mentioned in the Option Advisor commentary, "I would remain quite defensive, looking to hedge any long stock exposure with shorts or with put positions on ETFs, including the "double inverse" ETFs on such still-vulnerable sectors as energy and technology."

Indicator of the Week: ProShares UltraShort Exchange-Traded FundsBy Joe Sunderman, Vice President of Financial Market Analytics

Background: In this age of exchange-traded funds (ETFs), we have seen a myriad of new and exciting instruments for investors to diversify their portfolios. During the past few years, ProShares has developed several ETFs that allow individual investors to gain exposure to the major market indexes. Additionally, ProShares has created ETFs that allow investors to hedge their portfolio with ProShares Short and ProShares UltraShort. The ProShares Short series is designed to rise when the underlying indexes fall. Furthermore, the ProShares UltraShort series is designed to double the inverse daily performance of their underlying indexes.

These instruments are not only useful for individual investors to hedge against a bear market, but they can be useful from a sentiment perspective, as well. By measuring the underlying volume of the ProShares UltraShort, we can gauge the current temperament of investors through these hedging vehicles.

In the accompanying graphic, we have cumulative volume for the 6 UltraShort ETFs that are based on major market indexes. To this point, I did not include sector indexes. The graph sums the underlying volume for the following ETFs: UltraShort QQQQ (QID), UltraShort Dow 30 (DXD), UltraShort S&P 500 (SDS), UltraShort MidCap 400 (MZZ), UltraShort SmallCap 600 (SDD), and the UltraShort Russell 2000 (TWM). Also included in the graph is the price action for the S&P 500 Index (SPX).

Data Interpretation: Historically, when the cumulative volume of the 6 major index UltraShort ETFs spikes, it has signaled that investors are looking to hedge or speculate on the downside of the market. During the past couple of years, spikes have coincided with short-term bottoms in the SPX. This indicator would have similar contrarian implications to jumps in the CBOE Market Volatility Index (VIX) and broad-market put/call volume ratios.

Current Reading: During the past 2 weeks, we have seen spikes of more than 210 million shares in cumulative volume. This level was hit on November 13 and November 20 on volume of 213,067,900 and 210,987,000, respectively. We note those dates in the chart above, along with October 6, when 200 million was breached for the first time.

Implications: Even though investors have been slow to adjust, it seems we are starting to see some early signs of wear and tear on investor sentiment. The cumulative volume on the 6 major UltraShort ETFs shows that investors

are looking for vehicles to loosen the bearish grip on their portfolios. There are other signs of a sentiment shift coming from International Securities Exchange call/put ratios, the CBOE Market Volatility Index (VIX) to SPX historical volatility spreads, and others. At this point, however, it is prudent to continue to brace your portfolio for more downside. An encouraging sign would be any negative news (i.e., economic reports) greeted by market rallies and bearish growth in investor sentiment.

Indicator of the Week: 5-Year Swap Rate versus 5-Year Treasury Bond YieldBy Joe Sunderman, Vice President of Financial Market Analytics

Foreword: On Wednesday, Treasury Secretary Henry Paulson announced changes to the Troubled Asset Relief Program (TARP). More specifically, the Bush administration would like to abandon the original purpose of the $700-billion rescue plan. As of last week, $290 billion had already been deployed to help banks, Wall Street, American International Group (AIG), and others. The revised plan is designed to help the American consumer. In the November 12 edition of the Financial Times, this shift was characterized as "targeting consumer credit by the ungumming of securitisation markets and aiming to reduce home foreclosures."

If you recall, the TARP was supposed to be a measure to help unfreeze the credit markets by bringing some confidence back to the banking system through the removal of low-grade assets (i.e. home mortgages, mortgage-backed paper, etc.). Last week's announcement was a major shift in the original TARP plan that Paulson and the Treasury set forth back in mid-September.

Today, I am going to look at a key measure to ascertain the TARP's success in impacting the credit market. To do this, I will closely compare the 5-Year Swap Rate versus the 5-Year Treasury Bond Yield.

Background: To gauge the action in the credit markets, 1 indicator that I watch is the spread between the 5-Year Swap Rate and the 5-Year Treasury Bond Yield. The swap spread measures the risk-free borrowing rate (5-Year Treasury) and the rate at which the market expects inter-bank borrowing (swap rate) to occur in the future. For example, if the 5-year Swap Rate stood at 3.52% and the 5-Year Treasury Bond Yield was 2.68%, the swap spread would be 0.84, or 84 basis points (3.52% - 2.68%).

Data Interpretation: Simply put, the higher the swap spread, the more perceived credit risk exists for banks. By graphing the data, you can see periods when the credit markets were under stress, as swap spreads expanded and concerns over inter-bank loans heightened.

Implications: By this measure, I still see trouble in the perceived risk by banks. It should be noted that since the introduction of the TARP on September 19, the 5-Year Swap/5-Year Yield has increased from 0.89 to its current perch at 1.04, and remains in an uptrend (near the upper quartile). Thus far, the impact of the TARP has not helped this indicator, and banks still seem defensive. On a more optimistic note, other measures of credit risk have improved (LIBOR, TED Spread). Bullish equity investors should continue to monitor the 5-Year Swap/5-Year Yield to determine if the new installation of the TARP will improve credit market situation.

Indicator of the Week: Is the VIX Showing Enough Fear?By Joe Sunderman, Vice President of Financial Market Analytics

Background: The Chicago Board Options Exchange (CBOE) Market Volatility Index (VIX) is a sentiment tool that measures the market expectations for near-term volatility. The VIX is constructed using the implied volatilities of a wide range of S&P 500 Index (SPX) options. This volatility is intended to be forward-looking, and is calculated from both calls and puts. The VIX is often referred to as an investor "fear gauge," as it provides insights to how the investor community views future volatility. During challenging market periods, the VIX will tend to rise, as investors brace for higher levels of volatility. On the other hand, during quiet market periods, a low VIX is a sign that investor fear is subsiding.

In past commentaries on the VIX, I have either focused on the absolute level of the index or its trend. Today, I will take a closer look at the disparities between the SPX's historical volatility and the VIX.

Data Interpretation: The accompanying graphs offer 2 different depictions of the VIX and the 20-day historical volatility of the SPX. The first graph shows the VIX's trend and the action of the SPX volatility since the beginning of the year. There are a couple of noteworthy developments to point out. First, until August 2008, the VIX traded at a premium to SPX historical volatility. In fact, going back 18 years, the VIX has traded at a premium to SPX volatility more than 90% of the time. Thus, the natural spread is for the VIX to trade at a premium to SPX volatility. Second, there has been an unusual development since August in the relationship between the VIX and the SPX's volatility - a discount. Such a development is abnormal, as it has occurred less than 10% of the time in the past 18 years, but has occurred in 25 of the past 36 sessions.

The graph below shows the difference between the VIX and SPX volatility. This graph is more revealing in terms of the spread between these 2 related indicators. When the difference between the indicators is above zero, the VIX is trading at a premium to the SPX's volatility. On the other hand, when this indicator goes below zero, the VIX is trading at a discount to the SPX's volatility.

Historically, there have not been many occurrences when the VIX premium traded at a 30% discount or more - aside from the past month. Below are the dates of such occurrences:

11/7/2008 -30.22%11/5/2008 -35.96%11/4/2008 -42.51%11/3/2008 -36.25%

10/21/2008 -33.92%10/20/2008 -34.15%10/14/2008 -38.44%3/23/2007 -34.71%3/22/2007 -36.97%3/21/2007 -41.32%8/16/2002 -37.03%8/15/2002 -37.50%

Implications: It is difficult to draw a quantitative conclusion when there are so few historical references to draw upon. I do feel that this discount in the spread is a troublesome development. I remain concerned with the complacency I am seeing among option players. Bulls would want to see the VIX trading at a steep premium to SPX volatility, as a sign that fear is rampant among the investing community.

Indicator of the Week: Bullish Momentum?By Joe Sunderman, Vice President of Financial Market Analytics

Background: Investors have received their fair dosage of volatility during the past several weeks. In fact, when looking at the difference between the SPX's intraday highs and lows, 6 of the past 7 weeks have experienced a high/low percentage of 10% or higher. Furthermore, the past week showed more of the same intraweek swings, with the SPX posting its fifth consecutive week where the difference in the intraday highs and lows was 10%. Looking at SPX data since 1950, we find that this is the longest streak of such volatility. Previously, the record was held by a pair of 3-week periods in October 1987 and July 2002.

In the final week of October, value investors finally came out to salvage a very destructive month for equities. As a result, the SPX rallied more than 10% on the week, posting its largest 1-week gain since October 1974. In this section of Monday Morning Outlook, we are going to take a look at the implications of large 1-week moves in the SPX.

Data Interpretation: For this week's analysis, I looked at SPX data going back to 1950 to see how many times the SPX has rallied more than 9% in 1 week. Unfortunately, there have been only 2 such occurrences. Given the lack of signals from which to draw a strong conclusion, I relaxed our parameters to study weeks when the SPX rallied 7% or more. Including last week's return, I found 10 total signals since 1950. Upon looking at these individual signals, there were 2 sets that occurred within weeks of each other (October 1974 and October 1982). As such, I excluded any overlapping signals and only included the first signal from a set of occurrences.

Implications: In the table below, I've included the 1-week through 3-month returns for the SPX following a weekly return of 7% or more. Standing out from this table are the returns from 3 weeks to 3 months. According to the data, the SPX returns on average between 2.47% and 9.13% during the 3 week-to-3 month time frame. When comparing these results to an "at-any-time return" for this period, these returns are approximately 5 times the market's performance during these individual time periods. Finally, when looking at past signals, the market has had a very high winning percentage.

Following the weeks of unstable price action, one can hope that the October 10 low (and subsequent retest on October 27) will be the market's key turning point, with last week's price action signaling that better days are ahead. Good-bye October, welcome November!

Indicator of the Week: The CBOE Market Volatility Index (VIX)By Joe Sunderman, Vice President of Financial Market Analytics

Foreword: During the past several weeks, Todd Salamone has been concerned with the VIX. Today, in my weekly commentary, I will dive into this indicator.

Background: The VIX is a sentiment tool that measures market expectations for near-term volatility. The VIX is constructed using the implied volatilities of a wide range of S&P 500 Index options. This volatility is intended to be forward-looking, and is calculated from both calls and puts. The VIX is often referred to as an investor "fear gauge," as it provides insights into how the investing community views future volatility. During challenging market periods, the VIX will tend to rise, as investors brace for higher levels of volatility. On the other hand, during quiet market periods, a low VIX is a sign that investor fear is subsiding.

Data Interpretation: There are a couple of methodologies to interpret VIX data. The most common interpretation is arrived at by comparing current VIX readings to prior readings. A different interpretation of the VIX is achieved by tracking the indicator's trend. We will focus on the latter interpretation in this commentary.

Current Reading: Beyond the market volatility that has gripped investors for the past few weeks, 1 of the more disconcerting developments we have seen is the "trendiness" of the VIX. The current trend has been very consistent during the past several weeks, as the fear barometer has found support from its short-term moving averages.

In the accompanying chart, we show a snapshot of the VIX with its 10-day moving average (red) and 20-day moving average (green) for the past 6 months. Standing out in this graphic is the fact that the VIX has not experienced a close below its 10-day moving average since August 28. Furthermore, the VIX has yet to close below its 20-day moving average since August 27.

Despite the fierce uptrend, the VIX has traded at a significant discount to the SPX's 20-day historical volatility. For comparison's sake, the VIX closed 34.15% and 33.92% below the SPX's 20-day historical volatility on Monday and Tuesday, respectively. For further perspective, the VIX normally trades at a premium to SPX historical volatility. During the past 4,800 market sessions (since January 1990), the VIX has traded higher than the SPX's historical volatility 90.5% of the time. Thus, we have seen the VIX trade at a discount to the SPX less than 10% of the time in the past 18 years.

Implications: We continue to be concerned that the VIX is trading either parallel or at a discount to historical volatility. One explanation could be that investors have so many different financial instruments to short the market (i.e. inverse and double-inverse funds and ETFs), hinting that SPX options are no longer the only player in town to hedge/speculate on the downside. We hope that the lack of fear premium is not a sign of complacency, which would be a significant concern in a harrowing market environment.

Indicator of the Week: Looking for CapitulationBy Joe Sunderman, Vice President of Financial Market Analytics

Background: In 1984, at the age of 81, Clara Peller became famous for her catch phrase "Where's the beef?" for Wendy's fast food restaurant chain. Amid the market turmoil that has wreaked complete havoc in world markets, this market analyst is asking, "Where's the capitulation?"

In today's commentary, we look at a couple sentiment barometers that are not showing the signs of capitulation – a complete surrender of investors- that one would expect amid this torrid price action. In this section, we will touch upon the American Association of Individual Investors' (AAII) survey, which tracks the sentiment of individual investors. We will also touch upon research conducted last week by my colleague Chris Prybal on put/call volume ratios.

Current Reading: During the past week, the S&P 500 Index (SPX) fell -6.74%. One would think that investors would be running for the hills following such market declines. But we did not see this behavior last week. In fact, the AAII bullish percentage actually rose from 31.47% to 40.94% - a net move of 9.47%.

To put some perspective on this unusual rise in bullish sentiment, we looked back at all data from the AAII when the SPX fell by 5% or more. In the accompanying table, we have dates, percentage market move, and AAII bullish percentage data.

Implications: Historically, when the SPX has declined by 5% in a week, the bullish reading at the AAII has averaged a rise of 1.71 points. Thus, this past week's market move emboldened investors to buy into this market at a significantly higher rate than in the past.

This "buy the dip" mentality was prevalent in the April 2000 to July 2002 period. During that time frame, 5% weekly pullbacks in the SPX were greeted with the bullish percentage rising an average of 6.58 points. We hope that the AAII ebbs lower in future surveys, as contrarians look for more bearish positioning that coincides with a market bottom.

Additional Concern: As mentioned above, Chris Prybal put together a great synopsis of the various put/call volume ratios that we track. Like the AAII figures, we have not seen put/call ratios jump to levels that marked previous market bottoms like that in March. It seems that the sharp drop of the past 2 weeks has left traders in a position that hedging at this point is not worth the risk in the face of a market bounce.

Indicator of the Week: Examining Magazine Covers for Qualitative SentimentBy Joe Sunderman, Vice President of Financial Market Analytics

Foreword: In this weekly column, we primarily focus our attention primarily on quantitative sentiment data to help us anticipate the next market move. Market surveys, volume of option activity, and measures of volatility based off of option premiums are examples of quantitative sentiment. In today's column, we revisit a qualitative sentiment measure: magazine covers. By monitoring the covers of major publications, one can gauge the extent that certain news has been factored into the market.

How to Interpret the Data: The basic tenet of cover-story evaluation is that when a stock becomes hot news (on either the bullish or bearish fronts), it could mean that the factors driving the shares are fully discounted into the stock's price. Periodicals are in the business of maximizing the sales of each issue. To achieve this goal, magazines will often jump on the hot topics of the day for their cover stories. We have found mainstream magazine covers to be an interesting contrarian sentiment indicator. When a financial trend is featured on a magazine cover, the chances are that this trend is already widely known, universally accepted, and has already been in place for a decent length of time. Thus, the likelihood of a potential turning point in the trend becomes more probable.

Current Reading: Unlike quantitative sentiment, there are no specific data readings for magazine covers. However, we can gauge the prevalence of the current trend by monitoring the number of cover stories that are chasing the same topic. Since mid-July, there have been 18 cover stories in the major periodicals that we track. All of these cover stories relate to the economy, Wall Street's challenges, and the upheaval of the financial market system. What is noteworthy is the fact that not only are business-themed magazines are covering Wall Street's slide, but so are more mainstream publications, such as Time and U.S. News.

In this age of technology and social media, we can measure whether or not the feelings in these magazine publications are resonating with John Q. Public. We can get the pulse of Internet bloggers through a Nielsen BuzzMetrics service appropriately named BlogPulse. One can search any term to measure how prevalent (percent of all blog posts) a word or topic is being covered in the blog world. In this particular case, we looked at "recession" and "great depression." In both cases, the frequency of these words in blogs have increased 2 to 3 times the average prior to September.

Implications: If there was ever a moment that the contrarian implications of magazine covers were needed, the time is now. Either we are in defining a classic contrarian moment or the mainstream media is accurately calling for a steep and prolonged recession, and in some cases depression. We hope in the former.

Indicator of the Week: The 5-Year Swap Rate Versus The 5-Year Treasury Bond YieldBy Joe Sunderman, Vice President of Financial Market Analytics

Foreword: Despite the turmoil seen in the equities markets this week, the bigger mess remains in the credit markets. According to an article in Bloomberg last week:

"The crisis deepened after the worst month for corporate credit on record. Leveraged loan prices plunged to all-time lows, short-term debt markets seized up and even the safest company bonds suffered the worst losses in at least two decades as investors flocked to Treasuries. Credit markets have frozen and money-market rates keep rising even after central banks pumped an unprecedented $1 trillion into the financial system."

Given this state of the credit markets, we felt it was necessary to address this issue in this week's commentary.

Background: To gauge the action in the credit markets, 1 indicator that we watch is the spread or difference between the 5-year swap rate and the 5-year Treasury bond yield. The swap spread measures the risk-free borrowing rate (5-year Treasury) and the rate at which the market expects inter-bank borrowing (swap rate) to occur in the future. For example, if the 5-year swap rate stood at 3.52% and the 5-year Treasury bond yield was 2.68%, the swap spread would be 0.84, or 84 basis points (3.52% - 2.68%).

How to Interpret the Data: Simply put, the higher the swap spread, the more perceived credit risk for banks. By graphing the data, one can see periods when the credit markets were under stress, as swap spreads expanded and concerns over inter-bank loans heightened.

Current Reading: On September 29, the swap-spread reading reached 1.21 – the highest reading taken during the past several years (my data goes back to 2000). To put this 1.21 reading in perspective, this is higher than the average swap reading for 2008 (0.87) by nearly 40%.

Click Here to Enlarge

Implications: The credit markets are frozen, as indicated by the swap spread's extremely high readings. This impacts not only financial institutions, but also non-financial companies that rely heavily on short-term debt (i.e. Caterpillar, General Electric). Additionally, this credit freeze is not only occurring at our financial institutions and corporations, but is having a trickle down effect to Main Street, as it is becoming more challenging to get loans for home and car purchases. All eyes are on the $700-billion federal bailout, as investors hope that the bill will grease a very dysfunctional credit market. We will continue to monitor this indicator to see what impact the bailout has on the credit markets.

Indicator of the Week: Schaeffer's Investment Research Equity-Only Put/Call RatioBy Joe Sunderman, Vice President of Financial Market Analytics

Foreword: In wake of the recent market volatility, we have seen several of our sentiment indicators show significant amounts of pessimism. For example, the Chicago Board Options Exchange's Market Volatility Index (VIX) has spent 8 consecutive sessions above the 30 mark. This has occurred on only 7 previous occasions. Another sentiment barometer, the Schaeffer's Investment Research Equity-Only Put/Call Volume Ratio, has seen high readings during the past couple of weeks. More specifically, from September 15 to September 18, we saw 4 consecutive sessions of readings above 1.0. It is rare to see a single session with a reading in excess of 1.0, let alone 4 consecutive days. In this commentary, we look at the significance of such readings.

Background: A put/call volume ratio measures the sentiment of the options crowd by tracking the number of call contracts (bullish bets) and put contracts (bearish bets) that change hands in a market session. The SIR equity-only put/call volume ratio is one such ratio that measures put and call volume for the front 3 months of options, allowing us to focus on current option volume among short-term traders.

How to Interpret the Data: In monitoring the SIR equity-only put/call volume ratio, we like to use a 21-day average to gauge the emotion of the crowd during a longer stretch. Historically, the ratio typically holds to a range between 0.40 and 1.0. At these peaks and valleys, sentiment is at an extreme and a market reversal becomes highly probable. However, a trend in the ratio can be very telling, giving indications as to whether fear is increasing (a climbing ratio) or subsiding (a declining ratio).

Current Reading: As mentioned in the foreword, the SIR equity-only put/call volume ratio registered the following readings: 1.220 on September 15, 1.071 on September 16, 1.067 on September 17, and 1.406 on September 18. Since 2000, a reading above 1.0 has occurred 3% of the time out of more than 1,900 readings. Four consecutive readings above 1.0 had never occurred until last week.

Implications: Given that there have never been 4 consecutive readings above 1.0, it is difficult to draw any conclusions with no historical data points. To quantify this data, we scaled back our criteria to find situations where the put/call volume ratio was above 0.90 for 4 consecutive sessions. In fact, there have been 5 clusters where there were readings above 0.90 since 2000. Previous readings occurred from July 8 through July 15, 2008; March 6 through March 11, 2008; March 1 through March 6, 2007; and September 17 through September 20, 2002. Historically, the S&P 500 Index (SPX) has gained 4.6% during the month following such series of high put/call volume readings.

Indicator of the Week: The CBOE Market Volatility Index (VIX)By Joe Sunderman, Vice President of Financial Market Analytics

Background: The Chicago Board Options Exchange (CBOE) Market Volatility Index (VIX) is a sentiment tool that measures the market expectations of near-term volatility. The VIX is constructed using the implied volatilities of a wide range of S&P 500 Index (SPX) options. This volatility is intended to be forward looking and is calculated from both calls and puts. The VIX is often referred to as an investor "fear gauge," as it provides insights to how the investor community views future volatility. During challenging market periods, the VIX will tend to rise, as investors brace for higher levels of volatility. On the other hand, during quiet market periods, a low VIX is a sign that investor fear is subsiding.

How to Interpret the Data: There are a couple of methodologies on how to interpret VIX data. Probably the most common interpretation is studying the current VIX readings relative to past readings. By comparing current VIX readings against historical levels, investors can gauge how high or low fear levels stand relative to past stressed financial markets. The higher the VIX reading, the higher the level of investor anxiety. A different interpretation of the VIX is tracking the trend on this indicator. Like the SPX or any other market measures, there are periods when the VIX trends higher, trends lower, or remains in a trading range. These patterns can be just as noteworthy as the level of the VIX.

Current Reading: After a fairly peaceful period where the VIX marched steadily lower from mid-July through late August, we have seen a significant shift in volatility during the past few weeks. The VIX has gone from an intraweek low of 18.64 on August 22 to a high of 42.16 on September 18. This move was significant from a couple of perspectives. First, the spike to 42.16 was the highest point in the VIX since October 4, 2002. Secondly, the 4-week percentage move from low to high of 126% was the fourth largest move since March 1997. The table below shows the previous percentage moves:

Implications: Historically, the market has experienced bullish tailwinds following VIX spikes of such magnitudes. Following the top-3 percentage moves, the market rallied +17.90% (2001), +8.01% (2007) and +2.39% (1997) in the 8 weeks following such spikes. Given the actions by Securities Exchange Commission (prohibition of short selling on 799 financial stocks), the Federal Reserve, and the U.S. Government (Fannie Mae, Freddie Mac, American International Group rescues), we will hopefully see some bullish implications in the weeks ahead following the recent fear spike.

Indicator of the Week: Investment PollsBy Joe Sunderman, Vice President of Financial Market Analytics

Background: In our April 28th commentary, I looked at the 4 primary investment polls that we track; including Investors Intelligence, American Association of Individual Investors, Market Vane, and the Consensus Index of Bullish Market Opinion. We revisit a couple of these surveys today, as we have seen noteworthy developments during the past week.

How to interpret the data: Surveys of investor sentiment make for excellent contrarian readings at extremes. On one hand, excessive bullishness can indicate that buying pressure has peaked and the risk of a negative surprise is heightened. If pervasive bearishness among investors exists, even bad news won't necessarily cause the market to go down any further, since the selling has already occurred in advance of this news.

Current reading: Following the S&P 500 Index's (SPX) decline of approximately 3% during the week of May 19, bullish investors scattered quickly back to the bearish camp. As seen by the table below, the American Association of Individual Investors (AAII) saw its bullish percentage drop from 46.30% to 31.36% this past week – a net loss of nearly 15 percentge points. The move was similar to that seen April 11 to April 18 when the AAII's bullish reading fell from 45.76% to 30.37%. Additionally, Investors Intelligence's bullish reading dipped 9.4 percentage points from 47.30% to 37.90%. The last time we saw a net loss of this size was the 10.80-percentage-ppoint decline from 41.90% to 31.10% during the week of March 7.

Implications: Just because we have seen the market decline amid a fresh batch of skepticism does not mean we are on a "buy" signal. I would say that the response we saw from these 2 major polls is encouraging from a intermediate to long-term bullish perspective. This skepticism creates conditions that are needed for future rallies. The timing of the rally is the real question.

The timing question is due to a few of our short-term indicators flashing concerns. In particular, our equity put/call volume ratios are beginning to base, which usually coincides with short-term market weakness. Also, we are seeing heavy call additions on the CBOE Market Volatility Index (VIX), and an ominous shape in the VIX Futures curve. These short-term indicators keep us in cautious mode.

articles when employed at schaeffer's investment research

Economy & Finance