Slowing Down for a Sentiment Check

Major averages hesitated on the road to higher prices Monday, providing an opportunity to check the signpost known as sentiment. Notwithstanding recent gains and excitement in some circles, doubt seemingly springs eternal, which has bullish implications if sentiment truly is a contrarian indicator.

As reported here, and elsewhere, last week was a watershed for shares, at least on a technical front. Among the technical accomplishments, the Dow Jones Industrial Average ended above its March closing high, creating a bullish signal for devotees of Dow Theory as it "confirmed" the recent breakout by the Dow Jones Transportation Average. Similarly, the S&P 500 eclipsed its April 23 high of 919.70, breaking above its long-term downtrend line. Meanwhile, the Nasdaq Composite surpassed 1500 for the first time since June 18.

Conventional wisdom suggests any one of those developments would be viewed as bullish by even casual followers of technical analysis. The combination of three -- each one "confirming" the bullish message of the others -- is a veritable jackpot. Therefore, one would have expected a rush of bullishness this week as erstwhile naysayers covered shorts, money poured in from the proverbial sidelines and momentum traders sought to extend recent trends.

Clearly, that wasn't the case Monday as the Dow dipped 0.6%, the S&P shed 0.4% and the Comp rose a mere 0.1%.

Against the backdrop of that relatively subdued session, and last week's technical "breakout," I was struck by the negative tone from various "gurus" Monday. In sum, the recent advance has not caused many bears to change their stripes while some heretofore optimistic strategists are seeing warning signs.

Pigs Get Slaughtered

In the latter category, Charles Biderman, president of Investment Research in Santa Rosa, Calif., recently declared a new bull market has begun, as reported here on April 25 . But Monday, Biderman reported turning "cautiously bearish," noting a slowdown in corporate buybacks and cash takeovers, and accompanying increase in stock offerings.

In the past two weeks, there have been $600 million in new cash takeovers and $5.5 billion in stock buyback announcements vs. new offerings of $7.5 billion and a rise in insider filings to sell shares, Biderman noted. For all of April, stock buybacks totaled $7.7 billion, less than half the monthly rate in the first quarter, while the $13 billion in new offerings more than doubled levels in both February and March. (Notably, Monday's big takeover announcement was a stock-for-stock transaction between USA Interactive ( USAI) and Lending Tree ( TREE).)

Citing these trends, TrimTabs' L1 metric -- a formula that incorporates new stock offerings plus insider selling minus cash takeovers and share buybacks -- has now turned bearish. The firm also estimates equity mutual funds suffered outflows of $900 million for the week ended May 1, snapping a string of six consecutive weekly inflows.

Meanwhile, the pace of new stock offerings is expected to increase this week, including the initial public offerings of DigitalNet and iPayment.

"We have reported many times since last July's initial upturn that after each market rally, corporate buying slowed and selling began," Biderman wrote. "We had hoped this time would be different but apparently not. We still think the market is in a bull market. However, there are always intermediate tops and bottoms."

Similarly, Kevin Depew, technical analyst at Dorsey, Wright & Associates, reported in mid-April that his firm's favored metrics remained largely bullish, as they'd first signaled on March 20.

But Monday, Depew emailed "we're finally beginning to see a higher degree of risk come into the marketplace."

Heading into Monday's session, 85.9% of New York Stock Exchange stocks and 79.5% of over-the-counter names were trading above their 10-week moving averages. Over 70% is considered a "high-risk area," Depew noted.

Meanwhile, the NYSE bullish percentage indicator was at 55.9% and the Nasdaq's comparable level 51.2%. Readings below 30% are considered quite bullish and above 70% very bearish. So, these longer-term signals aren't bearish yet, but they're headed in that direction. (Bullish percentage figures are calculated by dividing the number of stocks trading on new point-and-figure buy signals by the total listed on either exchange. Point-and-figure charts are pure price charts that plot supply and demand without factoring in time or volume.)

"We never try and anticipate our anticipators, so to speak, but risk is obviously very, very high in the short term and getting a bit more dangerous for the intermediate and longer term as well," Depew wrote. "Those putting new money to work here are essentially picking up dimes in front of a bulldozer, or in racetrack speak, betting dollars to win nickels."

Still Bearish After All These Gains

Meanwhile, the advance has done little to convince skeptics they're wrong (and I'm not talking about the hard-core, permabear types).

The past nine months "has either been a base for a new bull phase, or a consolidation, that eliminates bearish thinking, but precedes the next leg down," according to Phil Erlanger, editor of Erlanger's Squeeze Play. "This is therefore a very dangerous time until we see a clear move one way or another."

To Erlanger, the clearly bullish trend others see won't be confirmed until the S&P exceeds 965, its intraday high on Aug. 22.

"A move above 965 with a big increase in short-selling, put-buying, and overall trepidation" would be most bullish, he wrote. Conversely, "the bearish scenario is that expectations become overly frothy without a clear break above 965, and the lows are broken sometime during the July to November seasonally weak season."

Despite the recent rise in short-selling -- short interest in Nasdaq hit a record 4.46 billion shares for the month ended April 15 -- Erlanger believes the "overly frothy" expectations part of the bearish scenario is occurring. "The 'must-be-in-the-market-at-all-times' crowd has fallen prey to the drunken crow," he wrote, referring to the market's zig-zag pattern the past nine months.

Separately, Alan Newman, editor of Longboat Global Advisors' Crosscurrents, issued a "special report" over the weekend, noting: "Our indicators of the market's internal dynamics are now at the same levels as they were at the March 2002 highs."

These indicators measure the relative strength of price, volume and breadth and their relationships to each other, Newman wrote, recalling the March 2002 highs were followed by "a period of slow pullback and consolidation until prices accelerated" from Dow 9900 in late May to the Oct. 10 intraday low of 7197.

The rising bullishness in Barron's "big money poll," near record-high equity recommendations of so-called major Wall Street strategists, and low cash positions of mutual funds suggest sentiment is "extremely optimistic," Newman concluded. (Others cite recent steep declines in the CBOE Market Volatility Index and its Nasdaq counterpart, which resumed Monday, as well as rising bullishness among American Association of Individual Investors' members and's Investors Intelligence survey.)

By most definitions, Newman is a permabear, or at least perennially skeptical, so some might dismiss his latest rant. But Jeffrey Saut, chief equity strategist at Raymond James, is not perma-anything. Thus, I was struck by the tone of his weekly report.

Saut has long been awaiting the Dow Theory buy signal referenced above. But instead of cheering its bullish implications Monday, he noted "many times when Dow Theory upside confirmation has taken as long as this one to finally occur, the markets are actually a short-term 'sell' on said confirmation."

Further observing most short-term indicators are "well overbought," Saut compared the market to a "galloping ghost," recalling an old tale about a horse who's hit by a truck in midstride, then jumps up and gallops another hundred yards before dropping dead.

Sentiment is in the eye of the beholder, but clearly the ghost of the post-2000 bear market continues to haunt many market watchers.

Aaron L. Task writes daily for In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to Aaron L. Task.

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