wmeubank@ocp.kcmo.com
THE OPTION ADVISOR
Prepared by
Investment Research Institute, Inc.
Let me take you back for a moment, to the sweet days of summer in mid-July–a carefree time for all associated with the stock market. The Dow Jones Industrial Average (DJIA) had been on a vertical climb since the spring and it had just vaulted above the 8000 plateau. After the first close above 8000, the optimistic emotion on Wall Street became so contagious that virtually everyone was shouting the praises of the stock market. Major television networks made it their lead news story, sportscasters on the radio declared that people were now reading the financial page before the sports page, and financial networks featured S&P 500 Index (SPX) futures traders who made millions simply by staying long. An environment steeped in such froth was destined for a decline. With the pullback now behind us and the DJIA once again pushed above the 8000 mark, it's interesting to note that the fanfare accompanying the first assault on 8000 is conspicuously absent. This is certainly encouraging because it implies more potential buying strength exists now than before, but it also brings to mind two more specific sentiment-related details that suggest the next market top will not occur anytime soon. First, the Consensus (Kansas City) Index of Bullish Market Opinion of stock index futures traders had been above 70% for three consecutive weeks in July, suggesting excessively optimistic sentiment that usually coincides with at least a short-term market top. Contrast that with the last three weeks' readings of 41%, 45%, and most recently, 57%. Clearly, the current environment lacks the euphoric optimism that corresponded with the July top, suggesting the likelihood of further advances. The second concept is that of “retests.” Major stock indices typically don't mark a single bottom before resuming the upward trend; the initial recovery often stalls and stocks drop lower before the next leg up can begin. What is often misunderstood is that major indices need not approach the actual market lows to effectively post a retest. There is a difference between a numerical retest and an indicator retest. For example, the decline in the DJIA that occurred on November 13 was a retest of the lows of October 28, even though it was numerically higher by 5.4%. The reason we can define it as a retest is that the extremes in pessimistic sentiment that accompanied the market bottom on October 28 were actually exceeded on November 13. For example, the equity put/call ratio was 0.55 on October 28, but 0.72 on November 13. Greater pessimism after a 5.4% advance was a very bullish signal. This suggests to us that the potential for a major advance in stocks remains vast.
December 5, 1997 Michael J. Oyster
Investment Research Institute, Inc.
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