A second reversal week?

Last week we anticipated going bearish on stocks and bonds as the market showed signs of caving in after the final “mopping-up” in Iraq. Indicators were falling into place, calling for a market top. Our window for the top to occur was to be from April 11, 2003 to April 16, 2003, with Friday the 11th or Monday the 14th being the most likely days. On Friday, we had an “outside-down day” and we completed an “outside down” week. These are two very strong indicators of an end of a rally.  An “outside-down” day or week means that the day or week begins making a new high, followed by closing at a new low by the end of the day or week.  This is a classic “reversal” scenario. Having both happen is usually the strongest case for a new bearish trend being started. Despite that and other indicators telling us the top was in, the market chose to resume a bullish pattern this week. Although we had a high degree of confidence in our view that the bear market would soon resume, we were ready to review alternate paths for the markets, just in case.

On Wednesday, the last day of our reversal window produced yet another reversal. And by the end of today (Thursday) we anticipate seeing another reversal week, again!  This is highly unusual, since a combination reversal day and week is usually all it takes for things to turn in the opposite direction. The bullish follow-through on Monday and Tuesday attests to the high degree of confidence both by advisors and by investors that there is nothing to fear in the market.  Another set of indicators, the volatility indexes (I call them anxiety indexes.) both declined yesterday, closing below their normal trading bands. When these indicators both close below their normal ranges, then reverse up from a significant low point, trouble lies ahead for the market.

Yet the lack of anxiety by investors and advisors is astounding. Investor’s Intelligence says that the bulls have outnumbered the bears for 26 straight weeks.  The percentage of bullish advisors is now over 51%, compared to
26% of the advisors who are bearish. According to Chartcraft, the ratio of small investors who are long (fully invested) in the options and futures market is 9 to 1! However, the ratio of commercials (hedge fund and institutional investors) is 4-to-1 short! In this situation, the commercials are considered the “smart money”.  Today,
the mutual fund cash-to-assets ratio is 4.35%, less than half the historic average.  This makes a very volatile mixture
and sets up the potential for a very steep sell-off in the markets.

We have been positioned in the inverse funds since last Friday. Although a few days early, we feel that we are well positioned for the next decline in the market.  Breaking news…In the Money and Investing section of today’s Wall Street Journal, we see the caption “Can It Be?  Faith in Tokyo Stocks?”  The following article states, “Global investor scars from Japan run deep.” And a chief investment officer from a global investment firm says,  “We don’t feel particularly euphoric about Japan coming to the top of our rankings.”  So there it is.  Things are beginning to change for the better in the Japanese market, as admitted by many Wall Street analysts, but they are very reluctant to commit themselves due to the long (13 year) decline in the Nikkei index. When money managers are this bearish, it’s time to sit up and take notice. Yet another opportunity is upon us. Our research shows the Scudder Japan
Equity fund having the best strength for this allocation.  It should show up in your account at the close of Monday.

Related posts:

1. Bullish Stance Justified on the Markets
2. Is the News Priced into the Markets?