wmeubank@ocp.kcmo.com
THE OPTION ADVISOR
Prepared by
Investment Research Institute, Inc.
As long-time readers of The Option Advisor know, the key to success in market timing depends heavily on pinpointing extremes in sentiment that are contrary to the underlying market trend. For example, in a bull market, extremes in pessimism are often powerful indicators that the market is about to undergo a period of outperformance relative to its average gains. The difficulty in doing this is defining whether or not the market is trending and then quantifying the various sentiment indicators. We mention this due to the recent excessive fear that has been evidenced in the market. Interestingly, this panic surfaced as the market approached long-term support levels, as defined by the 200- day moving average. The Dow Jones Industrial Average has not experienced a close below this trendline since the beginning of this awesome bull market phase in late 1994. This implies that the long-term uptrend remains intact. As the Dow rallied off support on November 13, the CBOE equity put/call ratio registered a phenomenally high 0.72 reading (a 0.60 ratio is typically bullish on an up day in the market). To our surprise and just five days later, the November 19th rally included a 0.64 equity put/call ratio, the second such bullish reading in four trading days. Mutual fund speculators have also shown signs of fear recently, reversing the rampant complacency seen before the steep decline on October 27. For example, the ratio of assets in the Rydex Nova Fund (which is a leveraged S&P index fund) to the assets in the Rydex Ursa Fund (a fund that is essentially short the S&P) declined to 0.55 one week ago. This means that almost twice the assets were committed to the “bear” fund as were committed to the “bull” fund. This is very near the low ratios that occurred at the July 1996 and April 1997 bottoms. At the October 27th bottom, the ratio was 1.00, which suggested there would be more short-term risk in ensuing weeks. The aforementioned indicators are bullish over the next few months, which means we may see a move back to the August peak, possibly by year's end. On a final note, we do want to reiterate that we haven't lost sight of the bigger picture. We are aware that market strategists, on average, are recommending a 55% weighting to stocks in their asset allocation models, which we find uncomfortably “top heavy.” Also, there is much publicized complacency from the average individual investor in response to market setbacks, and we foresee a time when the “buy on the dip” mentality will backfire. We will rely heavily on our market-timing tools to communicate to you when this mentality will indeed recoil.
November 21, 1997 Todd Salamone
Investment Research Institute, Inc.
1259 Kemper Meadow Drive, Suite 100, Cincinnati, Ohio
Consensus National Futures and Financial On Line Index
Hosted by:
One Crossroads Place
610 West Maple Ave, Suite WWW
Independence, MO 64050
(816) 252-4080
sysop@kcmo.com