Separating Signal From Noise: What Does Sentiment Suggest for Future Returns

On July 24, SPY made its all time high. That same day, the number of AAII bulls in their weekly survey of retail investors was only 30%. In fact, this was a large drop from 45% bulls in mid-June and at nearly a 3 month low.

For many, this was a signal that further gains lay immediately ahead for equities. Markets don't topple when so few are bullish, went the dominant line of reasoning. The chart below was posted on a popular blog at the same time. Note the author's headline (click for a larger version).

A Sign of Possible Capitulation: Trin Closes Over 2.0

Trin (also called the Arms Index) closed above 2.0 today. This is usually a positive for equities, at least over the short-term.

Trin is a breadth indicator. It is derived by dividing the advance-decline ratio for issues by that for volume. A close over 2 means that down-volume was twice down-issues; in other words, stocks fell on relatively high volume.

At a minimum, stocks have very often been higher the next day and also higher 5 days later. This is particularly true when the spike higher in Trin has occurred after several days of selling, like now. In the chart below, the vertical lines are Trin spikes over 2 during the past 2 years.

Many of these Trin spikes, especially in the past year, have also come at important lows: September, February and April, for example. In June 2013, the Trin spike was 3 days before the low after the market had been falling for 4 weeks. In other words, a spike in Trin can mark capitulation.

The biggest failures in a Trin spike coinciding with a relative low in equities usually occur when the spike comes after stocks have been on the rise. In October and November 2012 and in February and June 2013, the spike in Trin occurred when SPX  was within a day of a 5 or 10-day high. It signaled a change in direction. That’s not the case here.

There are never guarantees, but we are likely to see SPX move higher in the next 1-5 days. That has been the pattern in the past. That doesn’t necessarily mean the end of the 2 week downtrend. The Trin spike in March this year was followed by higher prices but also preceded the eventual low a month later, in April.

Signs Of A Washout In Utilities

The utilities ETF, $XLU, is now off more than 10% from it’s high.  Among the nine SPX sectors, its performance in the past 2 months has been the worst.

The main part of the (initial) fall is likely to be over.

Zero companies in the XLU are now above their respective 50-dma. In the past 4 years, this level of ‘breadth’ has been very close to a low in the sector’s price (red circles). It's not always the exact low, but close. A scenario like that in 2010 - a bounce followed by a lower low - is possible over the medium term

Weekly Market Summary

Despite the large fall this week, the longer term technical picture for SPX is positive. We will discuss the shorter term perspective in a moment, but for traders with a long time horizon, a return to the recent highs is odds-on.

July ended a streak of 5 positive months in a row. Since 1982, that type of strength has never marked a long term top.  The worst outcome was a sideways market for several months (2004 and 2005). When the market fell, it was short and the losses were reversed. For investors fearing a crash, that would be out of character with prior tops. If a top is being put in, price will oscillate positive and negative over the next several months. A retest of the recent high is more likely to happen first.

August Macro Update: Trend Growth of 2%

In May we started a recurring monthly review of all the main economic data (prior posts are here).

Our key message has so far been that (a) growth is positive but modest, in the range of ~4% (nominal), and; (b) current growth is lower than in prior periods of economic expansion and a return to 1980s or 1990s style growth does not appear likely. This is germane to equity markets in that macro growth drives corporate revenue and profit expansion and valuation levels.

This post updates the story with the latest data from the past month. The overall message remains largely the same. Employment is growing at less than 2%, inflation is less than 2%, wages are growing at less than 2% and most measures of demand are growing at roughly 2% (real). None of these has seen a meaningful and sustained acceleration in the past 2 years.

We'll focus on four categories: labor market, inflation, end-demand and housing.


Employment and Wages
The July non-farm payroll (209,000 new employees) was in the middle of a 10-year range. This follows prints of 84,000 in December and 288,000 in June. Moving between extremes like these is nothing new: it has been a pattern during every bull market. Since 2004, every NFP print near or over 300,000 has been followed by one near or under 100,000 (circles).