Sentiment - The Obvious is Obviously Wrong Brains and A Bull Market

Don't ever confuse being in a Bull Market with Brains; it is easy to look smart in the midst of a Bull Market when one stupid theory after another comes out and is splashed all over the front pages as the Media leads the cheerleaders, such as the professor who projected 36000 DOW in 2000. If you can recall one thing, remember that if everything you think you know is also known by everyone else, it is not worth knowing and should definitely not be used as a basis for making trading decisions.

Today we are in the middle of a takeover and buyout craze that in the past has always coincided with BLOW-OFF MARKET TOPS. But nonetheless all kinds of theories and analysis are being trotted out to justify why the market is undervalued: And yet this is happening in the face of a bursting real estate bubble, accompanied by rising interest rates, energy costs and inflation, combined with projected declining profit margins and a slower GDP rate of growth; all of which has always presaged severe market sell-offs. What gives?

MARKET OPINIONS are like noses, everyone has one and so do I, and mine is no better than the next one, even if a little prettier. But one thing I am sure of is history repeats and there are a few solid tried and true market TRUISMS that never fail that I have always tried to educate you in the past to justify any opinions I might hold. Two of the most reliable are:

# 1 NEVER FIGHT THE FED

The first and most important one is: Never Fight the FED. Sometimes it is difficult to ascertain what the FED is doing, especially since they stopped publishing M3 figures right after they raised FED Funds rates 17 straight times in a row. You would have thought that they were tightening Credit and shrinking the Money Supply, but upon careful examination that was not the case. In reality, they were flooding our economy as well as the rest of the World with money, east credit and even easier credit qualifications. The results were as sure as night follows day; a BOOMING Real Estate Market and Take-Over and Buy-Out craze that is naturally accompanied by an ever expanding Stock Market. Since the FLOOD of easy money is being spread worldwide, every Stock and Real Estate market in the world broke out to new all time highs. So regardless of what you think the fundamentals are or should be telling us, the FED's actions trumps all: This naturally leads to

# 2 SENTIMENT

The second rule is to never fight extremes in sentiment. Even though I have had, because of fundamentals, a Bearish Tilt on the Market and Real Estate for some time now while holding an extremely Bullish view on Gold, I have continued to caution you to take heed of the sentiment figures, which were warning us that this roaring Bull Stock Market was not yet ready to roll over , while at the same time, the Gold market had not yet finished its consolidation. Not only because of the time element needed to consolidate a 300% move, but also due to the sentiment figures that were warning us that the Gold Buyers were much too Bullish, while the Stock Market was and is much too Bearish given the 6 month steady rise in stocks worldwide.

NOTE: last week the reported short interest increased by 7% to an all time record high

GOLD STOCKS ALWAYS LEAD THE GOLD BULLION MARKET

The Gold Stocks were and are still in their corrective phase and as long as their bases are not completed and have not started heading up, Gold Bullion was and is not yet ready to enter its next explosive Bullish Phase.

MEASURES OF SENTIMENT

Over the years, I have been receiving a great many inquires about how do we know what the prevailing sentiment is and how can we measure it. The VIX and VIN used to be excellent indicators predicting both tops and bottoms, but for the last year or so they seem to have stopped working. In actuality, they were working very well only we did not recognize it or believe what we were seeing. They did foretell the extended record bull phase, not seen since 1927 and 1929 that the markets are now in. But since I didn't have the same extensive experience with them as I would have liked to have had, I did not pay enough attention to them.

ODD LOT AND FLOOR TRADERS SHORT SALES

I will now introduce you to the oldest tried and true measures of sentiment that I stopped giving as much attention to as they deserved because in this age of computers, their numbers are still reported two weeks late. Nevertheless, they are leading indicators and were never meant to pinpoint the exact day of a change in market direction, yet they are still the best because they have been around the longest and should be watched on a regular basis. They are the ODD-LOT SHORT SALES and the FLOOR TRADERS SHORT SALES as reported by the SEC.

The NYSE Members Report is compiled by the SEC and issued about two weeks after the applicable date. Every short seller anticipates a declining stock market. A profit is made if the stock is bought back at a lower price than when it was sold short. Odd lot transactions are made by small investors who can not afford to buy or sell short a round lot of 100 shares of a stock. In the old days, this indicator reflected the shorting activity of the smallest of the small guys who were usually dead wrong at bottoms and tops. However, since the introduction of options, it has lost a lot of its value. Many traders also sell in 99-share lots in fast markets for a better execution of their orders. Also, year-end tax selling and subsequent reinvestment distort the odd lot statistics in the end of December and early January every year. But the odd lot short sales are nevertheless an excellent indicator to measure prevailing negative sentiment in the market. The first chart below shows the 4-week moving average of the weekly odd-lot short sales. The second chart shows the weekly short sales of the more sophisticated and informed floor traders also on a 4-week moving average.

Floor Traders Short Sales

As can be plainly seen by the extremely Bearish sentiment in the face of 6 months of straight up markets that keep breaking out to new all time highs, the Stock Markets are not yet ready to collapse. Nor are these indicators even close to giving us any warning signals that the Bull Market is over.

The AAII (American Association of Individual Investors)

The AAII sentiment survey is a weekly poll conducted by that organization which intends to gauge the overall sentiment of their membership. Like most contrarian indicators, when the survey shows too many investors as being bullish, it very often corresponds to market highs. Conversely, too many bears suggest that the market may soon find a low. Due to the noisy week-to-week nature of this survey, Its advisable to follow the 4-week moving average of that ratio. The bull ratio is calculated as follows:

AAII BULL RATIO = % BULLS / (% BULLS + % BEARS)

The AAII percentages are available each week in Barron's.

GUIDELINES:

On the Bullish, Bearish and Bull Ratio charts, the ratios are plotted with Bollinger Bands, a measure of volatility. The upper and lower band lines are 1.5 and 2.0 standard deviations from the one-year average reading, so when the ratios exceed those bands, we know we're seeing an extreme.

As a contrary indicator, when the ratios exceed the upper band lines, then that's an indication that individual investors are too bullish on the market, and we should be watching for a potential decline. Conversely, when the ratios drop below the lower green bands, then we know that folks are overly pessimistic and a market rally is more likely to ensue.

68% of readings (1 standard deviation) should be between 51% and 71%

95% of readings (2 standard deviations) should be between 41% and 81%

99% of readings (3 standard deviations) should be between 31% and 91%

In other words, we should expect a reading under 41% or over 81% approximately 13 times per year.

SELL IN MAY AND GO AWAY

This may be the only reliable, tried and true TRUISM that is warning us to take some money off the table, but is not recommending the taking of any short positions. Remember there are always opportunities to go short, even in the wildest of Bull Markets, but that is best left to those who really know what they are doing.

CONCLUSIONS

THE STOCK MARKET

The Fundamentals of our economy stink and are getting worse. There are plenty of good contributors to this site who have outlined all the facts for you. But these are the facts that everybody knows, so what use are they? Don't fight the FED, the market is going higher. Our stock market is overvalued and out of balance. Sentiment numbers are still not calling for any significant TOP: Should we be selling and going short? NOT unless you want to go broke. If you want to sleep well at night, you can start talking cash off the table and build your buying power.

GOLD

Gold is in exactly the same but opposite position as the stock market. Everyone knows the tremendously favorable fundamentals as they are continually being highlighted by some very knowledgeable contributors here on GOLD-EAGLE.com. BUT the timing and sentiment figures are still not favorable enough yet. Gold has yet to finish its consolidation, and the Gold stocks have not yet formed their base. Now you can see why you should be building up your cash position, so you can take advantage of Gold's coming Wave III explosion.

ELLIOTT WAVE

As hard as I've tried to produce a good reading, the best that I can come up with is one that has three alternate counts which, for all intent and purpose is useless. Hopefully I will be able to spot the end of Gold's consolidation as well as the Stock Market's final top, in time for us to take maximum advantage and come up with a correct and useful Elliott Wave analysis that will be able to project the minimum and probable extent of Gold's next Bullish phase. Until then you can either build your cash positions and wait or you can do the following:

SCALING IN AND SCALING OUT

For over two years now, I have been warning you that the best way of making the most money out of a Bull Market is to be an Investor and not a Trader and since we never know what the exact lows or highs are until long after the fact, the best way of doing that is by Scaling in and Scaling out. If we can establish our positions an average of 15% off the bottom and get out 15% from the TOP, that would mean that we have captured 70% of the entire move and that my friends is the best that I can hope for.

GOOD LUCK AND GOD BLESS

Aubie Baltin CFA, CTA, CFP, Phd. (retired)

Palm Beach Gardens, FL

[email protected]

561-840-9767

29 May 2007

The above information has been gleaned from information that I believe to be reliable but is not guaranteed by me. The information provided is strictly for educational purposes and is not meant to be used as investment recommendations.