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Articles when employed at Schaeffer's Investment Research

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This a compilation of some of my work in 2008 at Schaeffer's Investment Research. These articles demonstrate a wide variety of topics related to the economy, stock market, and various indicators.

This a compilation of some of my work in 2008 at Schaeffer's Investment Research. These articles demonstrate a wide variety of topics related to the economy, stock market, and various indicators.

Published in: Economy & Finance

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  • 1. A Look at the Ascending Treasury Yield CurveMeasuring Treasury data against a chart of the S&P 500 Index (SPX)By Joseph W. Sunderman (jsunderman@sir-inc.com)11/19/2008 10:45 AM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usSome 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 Barronsthis 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 2002and 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 theaforementioned Barrons article). As seen by the chart, when the Treasury spread gets to 2.5 percentage points (or250 basis points), the SPX has been able to find some kind of bullish traction. This is not to say that the initial moveover 2.5 indicates a bullish signal in short order, but it does provide (hopefully) an encouraging sign that theeconomy may see a turnaround in the latter half of next year.
  • 2. From Main Street to Wall Street, Bearish Bets Build on theRetail SpaceSentiment is negative toward retailers across the board as we enter the holiday shoppingseasonBy Joseph W. Sunderman (jsunderman@sir-inc.com)12/4/2008 11:50 AM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usWith many retailers reporting their November sales today, sentiment toward this group can only be described asskeptical. From Main Street consumers to Wall Street options players and brokerage houses, there is unifiedsolidarity when it comes to being bearish on retailers.In todays Wall Street Journal article, "Holiday Shoppers Lured Only by Big Bargains," the author states that onlydeep discounts and promotions are keeping many consumers spending. Furthermore, "Americans are shopping, butonly if the bargains are right. That puts retailers in a no-win situation for the duration of the Christmas season: Theymust 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 brokeragehouses 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 numberof 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 theretail space.
  • 3. Option players maintain the same downbeat sentiment as brokerage firms. Below is a chart of the aggregate put/callopen interest ratio for the retail sector, along with a chart of the S&P Retail Index (RLX). The current ratio stands at0.926, 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 currentreadings are 15% to 27% higher than those taken in the past few years.
  • 4. Joseph W. Sunderman, as VP of Financial Market Analytics, oversees a team of Quantitative Analysts who areresponsible for managing the proprietary/non-proprietary databases and supporting the firms traders with filters,screens, and ad hoc studies. He was ranked by Bridge Information Systems as one of the top 10 market analysts for3 straight years for his commentary and stock picks found in Schaeffers Daily Bulletin. Joe has been published inthe Market Pulse Journal and Chartpoint, and his market comments have been printed in USA Today, The WallStreet Journal, Barrons, Investors Business Daily, Dow Jones Newswire, and Reuters.<-Joseph W. Sunderman (jsunderman@sir-inc.com)Unusual (Buy-To-Open) Option Activity Ahead of ThisWeeks EarningsA look at ISE option activity on SearsHolding (SHLD), Toll Brothers (TOL),Marvell Technology (MRVL), and Novell
  • 5. (NOVL)By Joseph W. Sunderman (jsunderman@sir-inc.com)12/1/2008 12:45 PM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usApproximately 70 companies are expected to report quarterly earnings this week, as we have some earningsstragglers still announcing. In todays commentary, we look at 4 stocks that have unusual buy-to-open option activitywith data used from the International Securities Exchange (ISE). This data is rather unique, as it looks at only optionactivity of buy-to-open variety, while excluding sell-to-open, sell-to-close, and buy-to-close activity. This is a morerefined 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 years worth of ratios. On the other hand, we also drawattention to those stocks with 10-Day Put/Call ratio averages in the 20th percentile or lower (in red). Morespecifically, 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 theirISEE put/call (or call/put) ratios. Thus, we are seeing option speculators who are positioning themselves verybearishly 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, PilgrimsPride (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%).
  • 6. Finally, each table below provides the price performance of the stock days, weeks, and months following the reportannouncement.Highlighted green cells are the sessions that are positive following the earnings announcement. The red highlightedcells 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 earningsannouncement. Readers can use these tables and historical performance results to trade around these stocks as theyapproach their individual earnings announcements.
  • 7. Joseph W. Sunderman, as VP of Financial Market Analytics, oversees a team of Quantitative Analysts who areresponsible for managing the proprietary/non-proprietary databases and supporting the firms Trader with filters,screens, and ad-hoc studies. He was ranked by Bridge Information Systems as one of the top 10 market analysts forthree straight years for his commentary and stock picks found in Schaeffers Daily Bulletin. Joe has been publishedin the Market Pulse Journal and Chartpoint and his market comments have been printed in the USA Today, WallStreet Journal, Barrons, Investors Business Daily, Dow Jones News Wire, and Reuters.A Look at U.S. Analyst Coverage on EquitiesExamining changes in analysts rankings overvarious market conditionsBy Joseph W. Sunderman and Robert Becks11/18/2008 1:21 PM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.us
  • 8. In a recent Financial Times article published on Monday ("US analysts least bearish among global peers"), therewas some interesting points that were made in regards to how U.S. brokerage analysts are positioned in thischallenging bear market. More specifically, U.S. analysts "remain markedly more bullish on stocks than peerselsewhere."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 imageStanding out from this graph is the fact that analysts have not significantly changed their posture during the pastseveral months. Despite the S&P 500 Index (SPX) shedding more than 40% on a year-to-date basis, the percentageof "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" therally 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 and2009." Thus, it will be noteworthy to see if the declines in earnings expectations will lead to future downgrades onU.S. equities in the coming months.<-Joseph W. Sunderman and Robert Becks
  • 9. ISE Buy-To-Open Call/Put Ratio Hits Multi-Month LowAre options traders on the ISE finallyaccepting the bearish trend in the equitiesmarket?By Joseph Sunderman (jsunderman@sir-inc.com)11/18/2008 11:50 AM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usAfter several weeks of weak price action in the broad-market indexes, signs are finally surfacing that optionspeculators are beginning to believe in the downtrend.At Schaeffers, 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 activityof buy-to-open variety while excluding sell-to-open, sell-to-close, and buy-to-close activity. This is a more refinedlook 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 thisparticular case, we have seen very few ISE equity-only buy-to-open call/put ratios (*100) that have dipped below100. This kind of positioning from option players has been perplexing and disconcerting from a sentimentperspective. Given that the S&P 500 Index (SPX) has lost over 40% on a year-to-date basis, its surprising to seeoption players having a call (optimistic) bias.
  • 10. In Mondays 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 thisratio dipped below 100 was January 17, 2008. Thus, yesterdays drop is only the sixth occurrence of ISE equity-onlybuy-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 wouldindicate that option players are finally giving into this bearish trend and are no longer trying to pick a marketbottom.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), andQualcomm (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 youd like to be alerted, and enter "Joseph Sunderman" into the third box.Easy as 1, 2, 3!-Joseph Sunderman (jsunderman@sir-inc.com)Member of the financial media? Click here.Analyzing 26 Sectors Performances During Recent Broad-Market RalliesAfter yesterdays eleventh-hour rally, we tooka look at some sectors reactions to recentsurges higherBy Joseph Sunderman (jsunderman@sir-inc.com)11/14/2008 11:20 AM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usFor 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, its 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 yesterdays vault higher, we decided to dissect 26 different sectors and their performances during theaforementioned 3 rallies from the past month. The results are displayed in the table below, with the various sectorslisted from best to worst single-day performance:
  • 11. As you can see from the chart above, the groups that performed the best (in terms of rank against peers) were thePHLX Oil Service Sector Index (OSX), S&P Insurance Index (IUX), AMEX Airline Index (XAL), CBOE S&PChemicals 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) werethe 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 theserallies. In looking at the trends, one can position themselves appropriately (through paired trades) when a snapbackrally 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 youd like to be alerted, and enter "Joseph Sunderman" into the third box.Easy as 1, 2, 3!-Joseph Sunderman (jsunderman@sir-inc.com)Member of the financial media? Click here.Small Traders Going Bullish on S&P 500 Index Futures
  • 12. Examining the Commitment of Tradersreport for small tradersBy Joseph Sunderman (jsunderman@sir-inc.com)11/11/2008 1:30 PM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usIn our weekly review of net positions of Commitment of Traders (COT), we noticed unusual positioning by smalltraders on S&P 500 Index (SPX) futures. This column looks at the quick transitioning of small traders from a verynet short position to now a positive long position.On a weekly basis, the U.S. Commodity Futures Trading Commission (CTFC) releases data known as theCommitment of Traders. COT reports provide a breakdown of each Tuesdays open interest for market reports inwhich 20 or more traders hold positions equal to or above the reporting levels established by the CFTC. The reportis broken down by Non-Commercial (a.k.a large speculators), Commercials (a.k.a. large commercial traders), andNon Reportable (a.k.a. small traders and speculators). In this commentary, we focus on the last group – small tradersand speculators.Below is a graph of small traders net positions since November 2003. What weve seen in the past week are smalltrader net positions going from -24,637 to 9,208 for a net change of 33,845. Looking at data since 1986, this is thelargest 1-week change that we have witnessed in our database.
  • 13. Historically, there are not many references from past data to draw conclusions from the data. We have seen only 3occurrences when small trader net positions went from a negative net positions to a positive one greater than 9,000contracts. These occurred in November 2006, September 2008, and May 2008. On average (over the 3 previoussignals) the SPX gained 1.77% during the next 4-week time frame.-Joseph Sunderman (jsunderman@sir-inc.com)Member of the financial media? Click here.Jobless Claims – Indicator Du JourExamining the jobless claims indicatorBy Joseph Sunderman10/30/2008 12:02 PM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usIf you catch any CNBC during the day, it seems that a weekly economic indicator that is getting more press of latehas 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 varythroughout 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 economicindicator. Today, the figure was 479,000 initial jobless claims, which was unchanged from the previous week andabove the average for the 2001 recession.Historically, this weekly indicator gets very little attention, while its monthly "cousin" – nonfarm payrolls - seems toget all the limelight the first Friday of each month. The initial jobless claims indicator grows in importance when theeconomy 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, whichimpacts 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 joblessclaims 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 itprovides insight into how the real economy is being impacted by the credit crunch.
  • 14. Click here to see the enlarged image-Joseph SundermanMember of the financial media? Click here.Buyer Strike or Simply Not Enough Sideline Money?Where and who are the buyers in this currentmarket?By Joseph W. Sunderman (jsunderman@sir-inc.com)10/23/2008 4:03 PM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usWith the market continuing to show volatility and unrest, the question that we have on our trading floor is where andwho are the buyers? Is there a buyer strike or not enough money on the sidelines that is not being put into use? Thiscommentary tries to answer these questions.A recent article from the Financial Times (10/21/08) stated:
  • 15. But traders, many of whom have been burned badly by the turmoil of the past 18 months, are reluctant to engage inthe bargain-hunting buying spree some have predicted. Evidence of this reticence can be found in the hedge fundsector 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 fromthe 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., andMillennium 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 pastseveral years. Their very absence could be a reason for the volatility and disjointed markets we have witnessed. Itseems 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 mutualfunds. One of the concerns from this group is the lack of cash that it has been holding for the last several years. Asseen by the accompanying graph, cash levels have ranged between the 3.5% to 4.5% range since early 2003. Suchlow cash levels raise two problems. First, when met with redemptions in times of market turmoil, equities (the mostliquid investment vehicle) need to be sold, as there is not enough cash on hand to meet redemptions. Second, sincecash 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 stockbuybacks are typically strong during periods when equity prices trade well off their peaks. Corporations demonstratethe confidence in their shares by buying back stock at discounted prices. It seems given that "cash is king" and thatcredit markets are far from optimally functioning, corporate stock buybacks may not be in the picture at this point.-Joseph W. Sunderman (jsunderman@sir-inc.com)Member of the financial media? Click here.
  • 16. What the 5-Week Options Expiration Cycle Means forStocksExamining the effects of 5-week expirationcycles on the S&P 500 IndexBy Joe Sunderman and Rocky White10/17/2008 9:35 AM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usThe October series of options expires today after the close, which means next week will begin a new expirationcycle. Most expiration cycles are 4 weeks; however, sometimes expirations can be 5 weeks. Next week heralds thestart of one of these 5-week cycles. Historically, weve found the beginning week of 5-week cycles to be bearish forthe market.Below is a table that shows weekly return data for the S&P 500 Index (SPX) since 2006. Notice that for all weekssince 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 significantlyworse, 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 11occurrences were positive. The last 5-week cycle was the September expiration. The first week of that cycle endedon August 22, and returned -0.46%. The last time one of these weeks was positive was February of this year, inwhich the week returned 0.23%.
  • 17. Implications: As the numbers indicate, it appears that the market may see some weakness as we head into the firstweek of the upcoming 5-week expiration cycle. The reason behind the pressure is due to the added emphasis onindex put accumulation. As these puts are added on the newly front-month series, hedging by market makers (in theform of short selling) could create headwinds for trading in the coming week. Additionally, given that there is moretime between expirations than usual, deltas are higher on the front-month options, which will require more hedgingthan a 4-week cycle.<-Joe Sunderman and Rocky WhiteIs This Volatility the New Wall Street?Dissecting the recent intraday swings thathave gripped the marketBy Joe Sunderman (jsunderman@sir-inc.com)10/17/2008 9:20 AM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usWelcome to the Tower of Terror. Unfortunately, this is not a themed roller-coaster ride at Disney, but one heck of athriller ride on Wall Street. Hope you packed your 6-pack of Pepto Bismol and Dramamine, because it has been avolatile ride the last couple of weeks.
  • 18. The intraday swings that have gripped the markets have been nothing short of astounding. Historically, this kind ofvolatility from intraday lows to intraday highs is nothing particularly unusual for the market. It is rare, but not asinfrequent as what may be perceived.As of Wednesdays close, weve seen 9 out of the last 10 sessions where the absolute value of the difference betweenthe intraday low and intraday high on the S&P 500 Index (SPX) was 1%. We have seen such volatility in pastmarkets: January 2003 October 2002 October – November 1987 October 1974 December 1973 June 1970 July 1950Thus, we are witnessing a fairly consistent and "natural" pattern of volatility that is associated with critical periodsin 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 worldcentral 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) isstill far from optimal levels.Third, hedge-fund money is probably the biggest influence on an intraday basis. Some hedge funds are probablyliquidating due to the need to meet redemptions, while other hedge funds are seeking to take advantage of thevolatility. Thus, you can get wild swings.In conclusion, the volatility will likely remain high until some of the uncertainty dissipates. This will first comefrom credit markets becoming more stable. Second, hedge-fund redemptions and deleveraging will need to slowdown, 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 signsof bottoming. This will only act as a confirmation that a floor has been put in on the market. However, all of thiswill take some time.-Joe Sunderman (jsunderman@sir-inc.com)Member of the financial media? Click here.
  • 19. Credit Markets Could Use Some Global WarmingExamining 3 indicators that could give insight into the frozen credit marketBy Joseph Sunderman10/15/2008 3:28 PM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usFor the past couple of weeks, investors have been hearing how the credit markets are frozen. As such, we have thetail of the credit markets wagging the dog of the stock market. In this commentary, we will look at what it meansthat the credit markets are frozen, while examining the indicators one should track to measure whether or not anythawing is occurring.The Frozen TundraFirst, a frozen credit market means that credit has become very difficult to obtain. Lending practices have becomevery restrictive and conservative, as there is less of a propensity of financial institutions to allow corporations, smallbusinesses, 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 lieuof 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 revealedwhen 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.
  • 20. The TED spread measures the difference between what banks pay to borrow from each other for 3 monthsand what the Treasury pays. According to data from Bloomberg.com, the TED spread has increased from1.13% to 4.56% since early September. Like the LIBOR, the TED spread has made an unusually largejump in a very short-time frame during the past few weeks.
  • 21. Finally, the spread between the 5-Year Swap Rate and the 5-Year Treasury Bond Yield is a measure Itrack and comment on in our weekly Monday Morning Outlook. The swap spread measures the risk-freeborrowing rate (5-Year Treasury) and the rate at which the market expects inter-bank borrowing (swaprate) to occur in the future. Simply, the higher the swap spread, the more perceived credit risk for banks. Bygraphing 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, thisfigure stood at 1.21 – near the highest levels in years.
  • 22. All 3 of these measures show that the credit markets are under duress. It has become very expensive for banks toborrow (and lend) money to other institutions. Thus, we have a significant crimp in the credit life line for theeconomy. 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 theactions taken by central banks and governments are making an impact on the credit markets. There will be morestability in world equity markets when the credit market situation stabilizes. Until then, we will still have bumps inthe road.Commitment of Traders: Large Speculators Backing Up theTruck on S&P 500 FuturesLarge Speculators jumping back into themarketBy Joseph Sunderman (jsunderman@sir-inc.com)10/14/2008 1:18 PM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.us
  • 23. Beep...beep...beep... Do you hear that sound of the truck backing up? Yes, that is the sound of large speculatorsloading up on S&P 500 Index Futures.On a weekly basis, the U.S. Commodity Futures Trading Commission (CFTC) releases data known as theCommitment of Traders (COT). COT reports provide a breakdown of each Tuesdays open interest for marketreports 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 commercialtraders), 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 ofthe S&P 500 Index (SPX) since 1994. Most noteworthy is the fact that large speculators currently have the largestlong 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 atprevious spikes (that were not as high) in large speculator net positions, the market has seen a tendency to bouncefor a few weeks following such positioning. Any bullish tailwinds at this point would be welcomed.<-Joseph Sunderman (jsunderman@sir-inc.com)Member of the financial media? Click here.ProShares UltraShort ETFs Pointing to Bottom?Examining growing trading volume on the
  • 24. ProShares UltraShort ETFsBy Joseph Sunderman (jsunderman@sir-inc.com)10/13/2008 11:35 AM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usIn this age of exchange-traded funds (ETF), we have seen a myriad of new and exciting instruments introduced forinvestors to diversify their individual portfolios. During the past few years, ProShares has developed several ETFsthat allow individual investors to gain exposure to the major market indexes. Additionally, ProShares has createdETFs that allow investors to hedge their portfolio with Short Proshares and UltraShort ProShares. The ShortProshares are designed to go up when their underlying indexes go down (and vice versa). Furthermore, theUltraShort 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 beuseful from a sentiment perspective. By measuring the volume of the UltraShort ProShares, we can gauge thecurrent 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), UltraShortSmallCap600 (SDD), and UltraShort Russell2000 (TWM). Also included in the graph is the price action for the S&P500 Index (SPX).
  • 25. During the past couple of years, we have seen significant spikes in the UltraShort cumulative volume associatedwith market bottoms (per each date). In light of the recent decline, the UltraShort cumulative volume on October 6thwas approximately 30% higher than any previous peak for the past 2 years. Thus, we are seeing signs ofcapitulation, as investors look for any instrument to hedge (or speculate) in this market downturn.Market Implications of the Federal Reserve Rate CutThe S&P 500 Indexs (SPX) reaction to ratecuts during the past 2 yearsBy Joe Sunderman (jsunderman@sir-inc.com)10/8/2008 10:30 AM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usIn a response to the global market turmoil, the U.S. Federal Reserve cut its federal funds lending rate by half apercentage point to 1.5%. This brief commentary shows how the S&P 500 Index (SPX) has reacted to rate cuts overthe 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 theSPX from the day of to 20 days following the rate cut. At the bottom of the table, we tabulated the average returnsand 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, withimplications of bullish tailwinds during the next month. We can only hope for the market to stabilize from the recenttreacherous conditions, as central banks across the globe make coordinated efforts.
  • 26. -Joe Sunderman (jsunderman@sir-inc.com)Member of the financial media? Click here.Not Enough Pessimism from a Major Sentiment Poll?What does Investors Intelligence data tell usabout the current market?By Joseph W. Sunderman (jsunderman@sir-inc.com)10/7/2008 3:34 PM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usInvestors 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 ofdata that this survey provides, analysts can measure the relative sentiment of todays market in comparison to pastmarket 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 bullishpercentage reading during the period, and the high and low bullish percentage reading during the pullback
  • 27. Looking at the table, the bullish sentiment, as measured by average, high, and low are fairly in line with past marketpullbacks of this magnitude.This is not to say that present bullish percentage readings are justifying a market bottom. Since late July, bullishpercentages have ranged between 31.8% and 40.7%. More noteworthy is the fact that the market has been settingnew lows while the bullish percentage has stayed in the range of the mid to upper 30s. Last weeks InvestorsIntelligence 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 markets volatility this week, we hope tosee a dip below the 30 level to reflect more of the pessimism necessary for a market bottom.<-Joseph W. Sunderman (jsunderman@sir-inc.com)Member of the financial media? Click hereA Look Ahead at Non-Farm PayrollsA look at the S&P 500 Indexs (SPX) reactionto non-farm payrollsBy Joseph W. Sunderman (jsunderman@sir-inc.com)10/2/2008 1:53 PM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usThe August Non-Farm Payroll release (on September 5th) saw a loss of 84,000 jobs, as the unemployment rate rosefrom 5.7% to 6.1%. On this news, the S&P 500 Index (SPX) rallied 0.44%. U.S. Non-Farm Payrolls will be releasedFriday 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
  • 28. as "rough." The average return after 5 days following the announcement has been -1.09. Additionally, the markethas 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 ofRepresentatives. This vote could influence the market, rather than the Non-Farm Payroll release in days ahead.<-Joseph W. Sunderman (jsunderman@sir-inc.com)Did the SECs Short-Selling Ban Really Limit Volatility?Examining the effects of the short ban onvolatility, liquidity, and bid-ask spreadsBy Joe Sunderman
  • 29. 10/2/2008 11:15 AM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usOn September 19, 2008, the U.S. Securities and Exchange Commission (SEC) banned short selling on about 800stocks. This move was done in an attempt to calm the markets in the midst of the current credit crisis. The ban wasoriginally 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 SECs short-ban list since that rule was put inplace. These returns were broken down by those with substantial short interest -- where short interest as a percentageof float (SI%) is greater than 8% -- and those with lesser short interest. We also include the returns of the broadermarket 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 thespikes of the SPX (green line) are more exaggerated than those of short-banned stocks (red and blue lines). Theredid not seem to be a significant difference in the performance of highly shorted stocks when compared to stockswith less short interest.Some argued that the short-sale ban would dry up needed liquidity in these stocks. Below, we take a look at theaverage 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 thedate that the SEC short-sale ban went into place. The average volume did fall off quite a bit immediately after theban; however, it didnt even fall back to the normal levels seen before September.
  • 30. Another measure of liquidity is to look at the bid-ask spreads on these stocks. That is what we do below. Again, thedate of the ban is marked. We see the spreads on these stocks rise up at about the time of the ban, and theyreextremely volatile afterwards.In looking at various angles of the short-ban rule, it appears that volatility decreased on these stocks, volumedecreased, and the bid-ask spreads became much wider and more volatile than previously seen.A Look at the CBOE Market Volatility Indexs SeptemberRally
  • 31. Examining the S&P 500 Indexs performancefollowing large spikes in the CBOE MarketVolatility Index (VIX)By Robert Becks and Joseph Sunderman10/1/2008 12:30 PM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.us"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 TwainMark 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. Since1980, the month of September has lost on average of -0.80%; the only month of the year to have negative returns onaverage. September 2008 saw a decline of -9.08%. During the past 28 years, this ranks as the second worstSeptember, only falling short of -11% decline in 2002.Given the volatility we saw in September, the CBOE Market Volatility Index (VIX) saw an extraordinarypercentage jump during the month. Looking at our data set since 1990, we find that the VIX jump was the highestmonthly increase, soaring 91% last month.Of the 224 calculated month-to-month VIX percentage-change readings, 23 of them were greater than 25%. Aftersuch occurrences, the market (as represented by the S&P 500 Index [SPX]) is usually positive during the next 1 to 6months, 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 surgesof 40% or more (bottom section of table). After those readings, the market has been positive more than 75% of thetime during the calculated return periods. More impressive are the fantastic SPX returns generated over the 2-, 3-,and 6-month periods following those signals. Lets hope the market responds similarly!
  • 32. -Robert Becks and Joseph SundermanMember of the financial media? Click here.ugust Option Advisor CommentaryExamining extreme investor sentiment in thecurrent market environmentBy Joseph Sunderman
  • 33. 8/6/2008 8:12 AM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usThe following is a reprint of the market commentary from the August edition of the Option Advisor, published onJuly 24. Prices and the chart are as of the close on July 24. For more information or to subscribe to the OptionAdvisor, click here.June was a particularly tough month for the equity market. The S&P 500 Index (SPX) lost 8.5% for the worst Junesince 1930. Unfortunately, the bleeding in June did not stop at the doorstep of July, as the market continued to sufferlosses 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 lowestreading they have recorded since surveys debut in November. A Merrill Lynch survey of global fund managers hascurrent sentiment toward equities as more negative than the period between from 2000 and 2003 (when marketswere much weaker). Additional concerns from fund managers lie ahead with a net 81% of respondents confidentthat consensus earnings estimates are too high for the next 12 months.
  • 34. As represented by Investors Intelligence poll, newsletter editors are having their own bear convention. The releaseof the survey on July 16th saw the bullish percentage at 27.8% and the bearish percentage at 48.9%. For thosestatisticians among the readers, the bearish reading is in the 95th percentile of all readings since 1990. The netdifference 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 3consecutive 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-Julys lows, we have seen some encouraging developments for the bulls beyond all thenegative sentiment. First, public enemy #1 - oil - has declined approximately 15% off its highs. Second, despite thesecond-quarter earnings being completely written off (before even being announced), the results (thus far) are not asbad as what was expected. As of July 21, positive surprises were leading disappointments by a 2.9-to-1 ratio, whichis inline with recent historical norms, according to Zacks . Additionally, despite the complete debacle that is goingon in the financial space, we are seeing many stocks rally upon their earnings announcement. It seems that some ofthe 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, andFreddie 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. Highstock 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 isa very volatile period for individual equities. Also, with the SPX only 4 to 6% off its lows, short-term volatility willlikely remain high, as it seems the dust has not completely settled.Turning our attention to implied volatility, the markets proxy for implied volatility is the CBOE Market VolatilityIndex (VIX). The VIX has dropped 27% since its intraday high on July 15th. The current VIX reading is lower than67% of all the readings for the past year. Such VIX readings reflect an options market that is trading at a discount inan 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. Volatilitywill be swift for both the bulls and the bears. Thus, it only makes sense to play both sides of the fence within aparticular sector. As a guest columnist in July 9s "The Striking Price Daily" in Barrons, Bernie Schaeffer wroteabout using options to mimic the strategy of long/short hedge funds. In the current climate, this paired options tradestrategy (like the one in the Put Sell portfolio) offers opportunities for premium buyers. Utilizing the convexity andleverage of options in a "hedge" play within a volatile sector may help savvy investors through this trying period.-Joseph SundermanMember of the financial media? Click here.June Option Advisor CommentaryPessimism from the financial media floodsthe market
  • 35. By Joseph Sunderman6/4/2008 8:56 AM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usThe following is a reprint of the market commentary from the June edition of the Option Advisor, published on May22. 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 Broadcasttelevision show. As I mentioned in the April Option Advisor commentary, there were 9 cover stories in popularbusiness and news magazines that all carried a very bearish tone from January through the end of March. Like thetelevision reruns during writers guild strike, it seems magazine editors collaborated to maintain and regurgitate thesame bearish theme in April and May."How To Fix Wall Street," "Fixing Finance," and "The Great American Slowdown" were all cover stories fromApril. Despite the broad-market indexes coming well off their bottom, this past week we saw a late-to-the-partyentry from a mainstream magazine, entitled "Surviving the Lean Economy." This adds up to 12 magazine coversfrom 7 different publications.This bearish theme is not only reflected in the media, but is a very representative sample that is consistent with awide swath of sentiment and fund flow measurements that we track. The following are bullet points on indicators wemonitor: 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 tothe longer-term trends in the S&P 500 Index (SPX) and the CBOE Market Volatility Index (VIX). As theaccompanying chart shows, after a tumultuous period in the first quarter of 2008, the 160-week moving average hasheld - despite of some trying drawdowns. Furthermore, the VIX break of its 40-week moving average in early Aprilwas a telltale sign of bullish tailwinds for the market. With this VIX trendline now beginning to rollover, we believethis is an encouraging sign for the bullish case.
  • 36. The underpinnings are there for a market bottom - skepticism in every corner of the market, as detailed by thebullets above. However, this is not to say that there are no headwinds in the near term. We have seen a few of ourvery 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, sentimentpolls, media, and short sellers are in consensus agreement with the challenges ahead, contrarians should viewpullbacks as potential buying opportunities.-Joseph SundermanMember of the financial media? Click here.April Option Advisor CommentaryExamining the heavy bearish sentiment inthe financial media
  • 37. By Joseph Sunderman4/9/2008 1:14 PM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usThe following is a reprint of the market commentary from the April edition of the Option Advisor, published onMarch 28. Prices and the chart are as of the close on March 28. For more information or to subscribe to the OptionAdvisor, click here.A common phrase that parents tell their children is "You cant judge a book by its cover." In other words, you shouldlook deeper before judging something. This idiom can be applied to one of our classic qualitative sentimentmeasures - magazine cover stories. Judging by the magazine cover stories during the past few weeks, one willrealize that the media has given roughly the same degree of coverage to the events roiling Wall Street as they haveto every utterance from the Democratic hopefuls. In fact, during the past 2 months, approximately 9 market-relatedcover stories have graced the jackets of 5 major publications - all with a consistent bearish tone. From BusinessWeekto The Economist and from Fortune to Newsweek, we have seen rampant concerns regarding the stock marketsvolatility, looming economic recession, stifling credit market crunch, and systemic problems of Wall Street. The listbelow 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 - "Its Rough Out There"Magazine cover stories have been important at key market bottoms throughout the past 30 years. Some of the titlesare now considered classic contrarian signals - "Recession Greetings" (1974), "The Death of Equities" (1978) , "TheCrash" (1987), "High Anxiety" (1990), "The Economy: Is there light at the end of the tunnel?" (1992), "How ToSurvive A Scary Market" (1994), "Jitters" (1996), "How Worried Should You Be?" (1998), "Americas BubbleEconomy" (1998), "Grin and Bear It" (1998), "Trapped: Alan Greenspans bubble nightmare" (1999), "The AngryMarket" (2002), "Whipsawed by Wall Street" (2003), and "Which Way is Wall Street?" (2006).
  • 38. We have never seen such an onslaught of negative cover stories in all our years of tracking the market. There arealways periods when there are 2 or 3 negative covers in a month, but nothing close to the degree we are currentlyseeing. The only period in recent memory where there was such a proliferation of negative magazine covers in ashort 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 OptionsTrading home-study program:"We have found mainstream magazine covers to be an interesting contrarian sentimentindicator. When a financial trend is featured on a magazine cover, the chances are that thistrend is already widely known, universally accepted, and in place for a decent length of time ofvery significant in magnitude."With so much media attention being given to financial market problems, does this mean all theskeletons are out of Wall Streets closet? The magazine cover indicator would suggest that someor all the worst has passed. In fact, the latest cover story of broken "Wall Street" (along withbreadth and interest rate indicators) signaled to one prominent market prognosticator that wehighly respect (Paul Macrae Montgomery) that it was time to turn his Intermediate Term StockModel positive.This is not to say that we are completely out of the woods. One indicator that tracks the skeletonsin Wall Streets closet is the spread between the 5-Year Interest Rate Swap versus the 5-YearTreasury Yield. This spread measures the risk (or willingness of institutions) to engage in a swap
  • 39. (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 usuallyspillover in the equity market. This spread reached a peak of 111 following the bailing out ofBear Stearns. Since then, this spread has declined to the mid-80s. We would want to see a moveback 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 normalrange.Turning our attention from the broad market, we see that its not hard to find a negative cover onhousing. Cover stories on housing include "How Toxic Is Your Mortgage" (9/11/2006), "Will theHousing 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 TheWorst Is To Come" (2/11/2008). As a contrarian, housing may be an area to consider a smallallocation of risk capital.On the other hand, technology has received a number of positive mentions and accolades on themagazine-cover front. Going back to the fourth quarter of 2007, "Tech is Back" (10/29/2007) ledoff the tech cover parade. Many of the recent covers are not sector specific within the tech groupbut company specific. Michael Dell was on a cover entitled "The Comeback Kid" (12/10/2007).Following that was "Googles Next Big Dream" (12/24/2007), "Company of the Year NVIDIA"(1/7/2008), "Building the Perfect Laptop" (2/25/2008), and "Americas Most Admired Company.Apple is No.1!" (3/17/2008). From our contrarian perspective, we have some growing concernsin the area of tech. One may want to consider an adjustment in allocation for this overlyoptimistic group.<The January BarometerA Study of the January BarometersEffectivenessBy Joseph Sunderman (jsunderman@sir-inc.com)2/1/2007 10:47 AM ET Discuss Email to a Friend Print Page Add RSS My Yahoo Del.icio.usBackgroundOne of the more popular and widespread indicators this time of year is the venerable January Barometer. The theorybehind the January Barometer was developed by Yale Hirsch in 1972. This theory goes like this: how the S&P 500Index (SPX) performs in the month of January, the rest of the year follows suit. For example, a positive return in
  • 40. January means a positive return for the market for the rest of the year. On the flip side, a loss in January means thatthe 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 wasaccurate 42 out of 50 years for an accuracy percentage of 84 percent. Drilling down further and looking at only thoseoccurrences 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, thisindicator has been correct only four times for an accuracy percentage of 57 percent.
  • 41. TakeawayJanuary 2007 was a bullish month with the SPX gaining 1.41 percent. It should be noted that the January Barometerhad only three "misses" for the past 57 years when the market had a bullish January and a negative return on the fullcalendar year (1966, 1994, 2001). Hopefully, this is an indication of future market gains in 2007.<-Joseph Sunderman (jsunderman@sir-inc.com)12/1/2008 Indicator of the Week: Nova/Ursa RatioBy Joe Sunderman, Vice President of Financial Market AnalyticsBackground: A sentiment indicator that we monitor each day is provided by the Nova and Ursafunds from the Rydex Series Trust. The Nova fund is designed to have a target beta of 1.5. Inother words, using equities, stock index futures contracts, and options on those securities andfutures, 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 Ursafund is designed to provide a performance inverse to that of the SPX by using a combination ofshort selling and options on stock index futures. Investors in this fund are considered bearish onstocks.Data Interpretation: We can get an accurate view of the sentiment picture by comparing theamount of assets in each fund. Specifically, we divide the total adjusted assets in the Nova fundby the total adjusted assets in the Ursa fund to arrive at a Nova/Ursa ratio. A high Nova/Ursaratio indicates an extreme amount of optimism (everyone investing in Nova – bullish fund). Alow Nova/Ursa ratio indicates an extreme amount of pessimism (everyone flocking to Ursa –
  • 42. bearish fund). We have frequently found that lows in the Nova/Ursa ratio precede rallies in theSPX, 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. Thecurrent reading for this sentiment measure is 0.89, meaning the adjusted assets of the Nova Fundamount to 89% of the adjusted assets in the Ursa Fund.Implications: Concerning us at this moment is the promptness of Rydex fund speculatorsmoving assets from Ursa Funds (bearish fund) to Nova Funds (bullish assets). Our interpretationof the data is that fund traders are looking for a bottom too readily. As seen by the previouspeaks in the data (circled areas on graph), this level of optimism (as defined by the Nova/Ursaratio) has been ill-timed the past several months. Given that the market is "overbought" byRelative Strength Index (RSI) measures, and the Rydex herd moving into bullish funds, werecommend defensive positioning following last weeks bear-market rally. As Bernie Schaefferhas mentioned in the Option Advisor commentary, "I would remain quite defensive, looking tohedge any long stock exposure with shorts or with put positions on ETFs, including the "doubleinverse" 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."
  • 43. With Fridays nonfarm payroll release, the relationship between the credit crunch and the real economy is comingfully into the light. Corporations are feeling the impact, and in turn, are making adjustments to cut costs to betterwithstand a slowing economic backdrop.In this section of Monday Morning Outlook, we take a look at the nonfarm payroll figures, which are released everyfirst Friday of the month by the U.S. Department of Labors Bureau of Labor Statistics.How to interpret the data: The nonfarm payroll figure represents the number of jobs added or lost in the economyduring the past month, but does not include those related to the farming industry. We watch this figure to gauge thestrength, 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 aclue as to how many people are employed or out of work, and indicates how much money will likely be put into theeconomy through the purchase of goods and services.Current reading: In this past Fridays 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 rateto its highest level in 15 years. The last time nonfarm payrolls fell by the degree they did last month was inDecember 1974. Looking at nonfarm payrolls data since 1939, this is only the seventh occurrence where nonfarmpayrolls have declined by 500,000 or more (in September 1945, February 1946, October 1949, July 1956, February1958, December 1974, and now, November 2008).Implications: Standing out from historical data of the DJIAs performance following a nonfarm-payroll decline of500,000 or more is the fact that the first months returns are positive, but remain below the "at any time" figure ofany 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.
  • 44. Coupled with the trend in nonfarm payrolls, a concern is the continued elevated levels of the 5-year swap versus the5-year yield. Since the credit crunch has been a significant factor in this economic slowdown and rising nonfarmpayrolls, the crunch still has some bite left in it. This will likely continue to weigh on the economy, employmentfigures, and the market in general.Indicator of the Week: Nova/Ursa RatioBy Joe Sunderman, Vice President of Financial Market AnalyticsBackground: A sentiment indicator that we monitor each day is provided by the Nova and Ursa funds from theRydex Series Trust. The Nova fund is designed to have a target beta of 1.5. In other words, using equities, stockindex futures contracts, and options on those securities and futures, the fund has a target performance benchmarkequal to 150% of the S&P 500 Index (SPX). Traders who invest in this fund are considered bullish on stocks.
  • 45. Meanwhile, the Ursa fund is designed to provide a performance inverse to that of the SPX by using a combination ofshort 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 ineach fund. Specifically, we divide the total adjusted assets in the Nova fund by the total adjusted assets in the Ursafund to arrive at a Nova/Ursa ratio. A high Nova/Ursa ratio indicates an extreme amount of optimism (everyoneinvesting in Nova – bullish fund). A low Nova/Ursa ratio indicates an extreme amount of pessimism (everyoneflocking to Ursa – bearish fund). We have frequently found that lows in the Nova/Ursa ratio precede rallies in theSPX, 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 thissentiment measure is 0.89, meaning the adjusted assets of the Nova Fund amount to 89% of the adjusted assets inthe Ursa Fund.Implications: Concerning us at this moment is the promptness of Rydex fund speculators moving assets from UrsaFunds (bearish fund) to Nova Funds (bullish assets). Our interpretation of the data is that fund traders are looking fora bottom too readily. As seen by the previous peaks in the data (circled areas on graph), this level of optimism (asdefined by the Nova/Ursa ratio) has been ill-timed the past several months. Given that the market is "overbought" byRelative Strength Index (RSI) measures, and the Rydex herd moving into bullish funds, we recommend defensivepositioning following last weeks bear-market rally. As Bernie Schaeffer has mentioned in the Option Advisorcommentary, "I would remain quite defensive, looking to hedge any long stock exposure with shorts or with putpositions 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
  • 46. Background: In this age of exchange-traded funds (ETFs), we have seen a myriad of new and exciting instrumentsfor investors to diversify their portfolios. During the past few years, ProShares has developed several ETFs thatallow individual investors to gain exposure to the major market indexes. Additionally, ProShares has created ETFsthat allow investors to hedge their portfolio with ProShares Short and ProShares UltraShort. The ProShares Shortseries is designed to rise when the underlying indexes fall. Furthermore, the ProShares UltraShort series is designedto 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 usefulfrom a sentiment perspective, as well. By measuring the underlying volume of the ProShares UltraShort, we cangauge 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 marketindexes. To this point, I did not include sector indexes. The graph sums the underlying volume for the followingETFs: 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 theprice action for the S&P 500 Index (SPX).Data Interpretation: Historically, when the cumulative volume of the 6 major index UltraShort ETFs spikes, it hassignaled that investors are looking to hedge or speculate on the downside of the market. During the past couple ofyears, spikes have coincided with short-term bottoms in the SPX. This indicator would have similar contrarianimplications 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 cumulativevolume. 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 thefirst time.Implications: Even though investors have been slow to adjust, it seems we are starting to see some early signs ofwear and tear on investor sentiment. The cumulative volume on the 6 major UltraShort ETFs shows that investors
  • 47. are looking for vehicles to loosen the bearish grip on their portfolios. There are other signs of a sentiment shiftcoming from International Securities Exchange call/put ratios, the CBOE Market Volatility Index (VIX) to SPXhistorical volatility spreads, and others. At this point, however, it is prudent to continue to brace your portfolio formore downside. An encouraging sign would be any negative news (i.e., economic reports) greeted by market ralliesand 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 AnalyticsForeword: On Wednesday, Treasury Secretary Henry Paulson announced changes to the Troubled Asset ReliefProgram (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. Inthe November 12 edition of the Financial Times, this shift was characterized as "targeting consumer credit by theungumming 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 someconfidence back to the banking system through the removal of low-grade assets (i.e. home mortgages, mortgage-backed paper, etc.). Last weeks announcement was a major shift in the original TARP plan that Paulson and theTreasury set forth back in mid-September.Today, I am going to look at a key measure to ascertain the TARPs success in impacting the credit market. To dothis, 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-YearSwap Rate and the 5-Year Treasury Bond Yield. The swap spread measures the risk-free borrowing rate (5-YearTreasury) and the rate at which the market expects inter-bank borrowing (swap rate) to occur in the future. Forexample, if the 5-year Swap Rate stood at 3.52% and the 5-Year Treasury Bond Yield was 2.68%, the swap spreadwould 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. Bygraphing the data, you can see periods when the credit markets were under stress, as swap spreads expanded andconcerns over inter-bank loans heightened.
  • 48. Implications: By this measure, I still see trouble in the perceived risk by banks. It should be noted that since theintroduction of the TARP on September 19, the 5-Year Swap/5-Year Yield has increased from 0.89 to its currentperch at 1.04, and remains in an uptrend (near the upper quartile). Thus far, the impact of the TARP has not helpedthis indicator, and banks still seem defensive. On a more optimistic note, other measures of credit risk haveimproved (LIBOR, TED Spread). Bullish equity investors should continue to monitor the 5-Year Swap/5-Year Yieldto 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 AnalyticsBackground: The Chicago Board Options Exchange (CBOE) Market Volatility Index (VIX) is a sentiment tool thatmeasures the market expectations for near-term volatility. The VIX is constructed using the implied volatilities of awide range of S&P 500 Index (SPX) options. This volatility is intended to be forward-looking, and is calculatedfrom both calls and puts. The VIX is often referred to as an investor "fear gauge," as it provides insights to how theinvestor community views future volatility. During challenging market periods, the VIX will tend to rise, asinvestors brace for higher levels of volatility. On the other hand, during quiet market periods, a low VIX is a signthat 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 willtake a closer look at the disparities between the SPXs historical volatility and the VIX.Data Interpretation: The accompanying graphs offer 2 different depictions of the VIX and the 20-day historicalvolatility of the SPX. The first graph shows the VIXs trend and the action of the SPX volatility since the beginningof the year. There are a couple of noteworthy developments to point out. First, until August 2008, the VIX traded ata premium to SPX historical volatility. In fact, going back 18 years, the VIX has traded at a premium to SPXvolatility 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 SPXsvolatility - a discount. Such a development is abnormal, as it has occurred less than 10% of the time in the past 18years, but has occurred in 25 of the past 36 sessions.
  • 49. The graph below shows the difference between the VIX and SPX volatility. This graph is more revealing in terms ofthe spread between these 2 related indicators. When the difference between the indicators is above zero, the VIX istrading at a premium to the SPXs volatility. On the other hand, when this indicator goes below zero, the VIX istrading at a discount to the SPXs volatility.Historically, there have not been many occurrences when the VIX premium traded at a 30% discount or more - asidefrom 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%
  • 50. 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 drawupon. I do feel that this discount in the spread is a troublesome development. I remain concerned with thecomplacency I am seeing among option players. Bulls would want to see the VIX trading at a steep premium to SPXvolatility, 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 AnalyticsBackground: Investors have received their fair dosage of volatility during the past several weeks. In fact, whenlooking at the difference between the SPXs intraday highs and lows, 6 of the past 7 weeks have experienced ahigh/low percentage of 10% or higher. Furthermore, the past week showed more of the same intraweek swings, withthe SPX posting its fifth consecutive week where the difference in the intraday highs and lows was 10%. Looking atSPX data since 1950, we find that this is the longest streak of such volatility. Previously, the record was held by apair 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 aresult, the SPX rallied more than 10% on the week, posting its largest 1-week gain since October 1974. In thissection of Monday Morning Outlook, we are going to take a look at the implications of large 1-week moves in theSPX.Data Interpretation: For this weeks analysis, I looked at SPX data going back to 1950 to see how many times theSPX has rallied more than 9% in 1 week. Unfortunately, there have been only 2 such occurrences. Given the lack ofsignals from which to draw a strong conclusion, I relaxed our parameters to study weeks when the SPX rallied 7%or more. Including last weeks 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 excludedany overlapping signals and only included the first signal from a set of occurrences.Implications: In the table below, Ive included the 1-week through 3-month returns for the SPX following a weeklyreturn 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 comparingthese results to an "at-any-time return" for this period, these returns are approximately 5 times the marketsperformance during these individual time periods. Finally, when looking at past signals, the market has had a veryhigh winning percentage.
  • 51. Following the weeks of unstable price action, one can hope that the October 10 low (and subsequent retest onOctober 27) will be the markets key turning point, with last weeks 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 AnalyticsForeword: During the past several weeks, Todd Salamone has been concerned with the VIX. Today, in my weeklycommentary, I will dive into this indicator.Background: The VIX is a sentiment tool that measures market expectations for near-term volatility. The VIX isconstructed using the implied volatilities of a wide range of S&P 500 Index options. This volatility is intended to beforward-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 marketperiods, 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 isarrived at by comparing current VIX readings to prior readings. A different interpretation of the VIX is achieved bytracking the indicators 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 moredisconcerting developments we have seen is the "trendiness" of the VIX. The current trend has been very consistentduring 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-daymoving average (green) for the past 6 months. Standing out in this graphic is the fact that the VIX has notexperienced a close below its 10-day moving average since August 28. Furthermore, the VIX has yet to close belowits 20-day moving average since August 27.
  • 52. Despite the fierce uptrend, the VIX has traded at a significant discount to the SPXs 20-day historical volatility. Forcomparisons sake, the VIX closed 34.15% and 33.92% below the SPXs 20-day historical volatility on Monday andTuesday, 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 SPXs historicalvolatility 90.5% of the time. Thus, we have seen the VIX trade at a discount to the SPX less than 10% of the time inthe past 18 years.Implications: We continue to be concerned that the VIX is trading either parallel or at a discount to historicalvolatility. 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 tohedge/speculate on the downside. We hope that the lack of fear premium is not a sign of complacency, which wouldbe a significant concern in a harrowing market environment.Indicator of the Week: Looking for CapitulationBy Joe Sunderman, Vice President of Financial Market AnalyticsBackground: In 1984, at the age of 81, Clara Peller became famous for her catch phrase "Wheres the beef?" forWendys fast food restaurant chain. Amid the market turmoil that has wreaked complete havoc in world markets,this market analyst is asking, "Wheres the capitulation?"In todays commentary, we look at a couple sentiment barometers that are not showing the signs of capitulation – acomplete surrender of investors- that one would expect amid this torrid price action. In this section, we will touchupon the American Association of Individual Investors (AAII) survey, which tracks the sentiment of individualinvestors. We will also touch upon research conducted last week by my colleague Chris Prybal on put/call volumeratios.
  • 53. Current Reading: During the past week, the S&P 500 Index (SPX) fell -6.74%. One would think that investorswould 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 theSPX fell by 5% or more. In the accompanying table, we have dates, percentage market move, and AAII bullishpercentage data.Implications: Historically, when the SPX has declined by 5% in a week, the bullish reading at the AAII hasaveraged a rise of 1.71 points. Thus, this past weeks market move emboldened investors to buy into this market at asignificantly 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 thatthe AAII ebbs lower in future surveys, as contrarians look for more bearish positioning that coincides with a marketbottom.Additional Concern: As mentioned above, Chris Prybal put together a great synopsis of the various put/callvolume ratios that we track. Like the AAII figures, we have not seen put/call ratios jump to levels that markedprevious market bottoms like that in March. It seems that the sharp drop of the past 2 weeks has left traders in aposition 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
  • 54. Foreword: In this weekly column, we primarily focus our attention primarily on quantitative sentiment data to helpus anticipate the next market move. Market surveys, volume of option activity, and measures of volatility based offof option premiums are examples of quantitative sentiment. In todays column, we revisit a qualitative sentimentmeasure: magazine covers. By monitoring the covers of major publications, one can gauge the extent that certainnews 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 (oneither the bullish or bearish fronts), it could mean that the factors driving the shares are fully discounted into thestocks price. Periodicals are in the business of maximizing the sales of each issue. To achieve this goal, magazineswill often jump on the hot topics of the day for their cover stories. We have found mainstream magazine covers tobe an interesting contrarian sentiment indicator. When a financial trend is featured on a magazine cover, the chancesare that this trend is already widely known, universally accepted, and has already been in place for a decent length oftime. 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 thesame topic. Since mid-July, there have been 18 cover stories in the major periodicals that we track. All of thesecover stories relate to the economy, Wall Streets challenges, and the upheaval of the financial market system. Whatis noteworthy is the fact that not only are business-themed magazines are covering Wall Streets slide, but so aremore 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 magazinepublications are resonating with John Q. Public. We can get the pulse of Internet bloggers through a NielsenBuzzMetrics service appropriately named BlogPulse. One can search any term to measure how prevalent (percent ofall 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 averageprior to September.
  • 55. Implications: If there was ever a moment that the contrarian implications of magazine covers were needed, the timeis now. Either we are in defining a classic contrarian moment or the mainstream media is accurately calling for asteep 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 AnalyticsForeword: 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 leasttwo decades as investors flocked to Treasuries. Credit markets have frozen and money-market rates keep rising evenafter 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 weeks commentary.Background: To gauge the action in the credit markets, 1 indicator that we watch is the spread or differencebetween the 5-year swap rate and the 5-year Treasury bond yield. The swap spread measures the risk-free borrowingrate (5-year Treasury) and the rate at which the market expects inter-bank borrowing (swap rate) to occur in thefuture. For example, if the 5-year swap rate stood at 3.52% and the 5-year Treasury bond yield was 2.68%, the swapspread 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. Bygraphing the data, one can see periods when the credit markets were under stress, as swap spreads expanded andconcerns over inter-bank loans heightened.Current Reading: On September 29, the swap-spread reading reached 1.21 – the highest reading taken during thepast several years (my data goes back to 2000). To put this 1.21 reading in perspective, this is higher than theaverage swap reading for 2008 (0.87) by nearly 40%. Click Here to Enlarge
  • 56. Implications: The credit markets are frozen, as indicated by the swap spreads extremely high readings. Thisimpacts 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 andcorporations, but is having a trickle down effect to Main Street, as it is becoming more challenging to get loans forhome and car purchases. All eyes are on the $700-billion federal bailout, as investors hope that the bill will grease avery dysfunctional credit market. We will continue to monitor this indicator to see what impact the bailout has onthe credit markets.Indicator of the Week: Schaeffers Investment Research Equity-Only Put/Call RatioBy Joe Sunderman, Vice President of Financial Market AnalyticsForeword: In wake of the recent market volatility, we have seen several of our sentiment indicators showsignificant amounts of pessimism. For example, the Chicago Board Options Exchanges Market Volatility Index(VIX) has spent 8 consecutive sessions above the 30 mark. This has occurred on only 7 previous occasions. Anothersentiment barometer, the Schaeffers Investment Research Equity-Only Put/Call Volume Ratio, has seen highreadings during the past couple of weeks. More specifically, from September 15 to September 18, we saw 4consecutive sessions of readings above 1.0. It is rare to see a single session with a reading in excess of 1.0, let alone4 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 callcontracts (bullish bets) and put contracts (bearish bets) that change hands in a market session. The SIR equity-onlyput/call volume ratio is one such ratio that measures put and call volume for the front 3 months of options, allowingus 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-dayaverage to gauge the emotion of the crowd during a longer stretch. Historically, the ratio typically holds to a rangebetween 0.40 and 1.0. At these peaks and valleys, sentiment is at an extreme and a market reversal becomes highlyprobable. However, a trend in the ratio can be very telling, giving indications as to whether fear is increasing (aclimbing ratio) or subsiding (a declining ratio).Current Reading: As mentioned in the foreword, the SIR equity-only put/call volume ratio registered the followingreadings: 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 consecutivereadings above 1.0 had never occurred until last week.
  • 57. Implications: Given that there have never been 4 consecutive readings above 1.0, it is difficult to draw anyconclusions with no historical data points. To quantify this data, we scaled back our criteria to find situations wherethe put/call volume ratio was above 0.90 for 4 consecutive sessions. In fact, there have been 5 clusters where therewere readings above 0.90 since 2000. Previous readings occurred from July 8 through July 15, 2008; March 6through 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/callvolume readings.Indicator of the Week: The CBOE Market Volatility Index (VIX)By Joe Sunderman, Vice President of Financial Market AnalyticsBackground: The Chicago Board Options Exchange (CBOE) Market Volatility Index (VIX) is a sentiment tool thatmeasures the market expectations of near-term volatility. The VIX is constructed using the implied volatilities of awide range of S&P 500 Index (SPX) options. This volatility is intended to be forward looking and is calculated fromboth calls and puts. The VIX is often referred to as an investor "fear gauge," as it provides insights to how theinvestor community views future volatility. During challenging market periods, the VIX will tend to rise, asinvestors brace for higher levels of volatility. On the other hand, during quiet market periods, a low VIX is a signthat investor fear is subsiding.How to Interpret the Data: There are a couple of methodologies on how to interpret VIX data. Probably the mostcommon interpretation is studying the current VIX readings relative to past readings. By comparing current VIXreadings against historical levels, investors can gauge how high or low fear levels stand relative to past stressedfinancial markets. The higher the VIX reading, the higher the level of investor anxiety. A different interpretation ofthe VIX is tracking the trend on this indicator. Like the SPX or any other market measures, there are periods whenthe VIX trends higher, trends lower, or remains in a trading range. These patterns can be just as noteworthy as thelevel of the VIX.
  • 58. Current Reading: After a fairly peaceful period where the VIX marched steadily lower from mid-July through lateAugust, we have seen a significant shift in volatility during the past few weeks. The VIX has gone from anintraweek low of 18.64 on August 22 to a high of 42.16 on September 18. This move was significant from a coupleof 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 belowshows 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) inthe 8 weeks following such spikes. Given the actions by Securities Exchange Commission (prohibition of shortselling 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 aheadfollowing the recent fear spike.Indicator of the Week: Investment PollsBy Joe Sunderman, Vice President of Financial Market Analytics
  • 59. Background: In our April 28th commentary, I looked at the 4 primary investment polls that we track; includingInvestors Intelligence, American Association of Individual Investors, Market Vane, and the Consensus Index ofBullish Market Opinion. We revisit a couple of these surveys today, as we have seen noteworthy developmentsduring the past week.How to interpret the data: Surveys of investor sentiment make for excellent contrarian readings at extremes. Onone hand, excessive bullishness can indicate that buying pressure has peaked and the risk of a negative surprise isheightened. If pervasive bearishness among investors exists, even bad news wont necessarily cause the market to godown any further, since the selling has already occurred in advance of this news.Current reading: Following the S&P 500 Indexs (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 Associationof Individual Investors (AAII) saw its bullish percentage drop from 46.30% to 31.36% this past week – a net loss ofnearly 15 percentge points. The move was similar to that seen April 11 to April 18 when the AAIIs bullish readingfell from 45.76% to 30.37%. Additionally, Investors Intelligences bullish reading dipped 9.4 percentage points from47.30% to 37.90%. The last time we saw a net loss of this size was the 10.80-percentage-ppoint decline from41.90% 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 areon a "buy" signal. I would say that the response we saw from these 2 major polls is encouraging from a intermediateto long-term bullish perspective. This skepticism creates conditions that are needed for future rallies. The timing ofthe rally is the real question.
  • 60. The timing question is due to a few of our short-term indicators flashing concerns. In particular, our equity put/callvolume ratios are beginning to base, which usually coincides with short-term market weakness. Also, we are seeingheavy 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.