Prechter: Technical Indicators Point Down from Here

Back in March of 2009 at the peak of bearishness when almost everyone else was predicting the end of the world (or at least the end of the stock market) Robert Prechter took an extremely contrarian position and called for a rally from that point and that is precisely what we got. Looking back that call seems almost prophetic. He called that bottom based on eight indicators which he said lined up on the bullish side.

In his April 2010 issue of the Elliott Wave Theorist Prechter predicted that these same eight indicators would switch from bullish to bearish by May 7th. Considering the events on May 6th and 7th he is once again sounding prophetic. This is extremely important as the media would have you believe that the events of May 6th were the result of a “fat finger”.Words: 1154

So says Tim McMahon (www.fintrend.com) in an article* in which he presents the following edited excerpts from Prechter’s article entitled “What Do These 8 Technical Indicators Mean for the Markets?”:

It is rare to have technical indicators all lined up on one side of the ledger. They were lined up this way—on the bullish side—in late February-early March of 2009. Today they are just as aligned but on the bearish side. Consider this short list:

1. Cash in Mutual Funds at All-time Low
The latest report shows only 3.5% cash on average in mutual funds which matches the all-time low that occurred in July 2007, the month when the Dow Industrials-plus-Transports combination made its all-time high. However, because the latest report pertains only through February, and in March the market rose virtually every day, there is little doubt that the percentage of cash in mutual funds is now at an all-time low, lower than in 2000 and lower than in 2007 showing the confidence that mutual fund managers and investors express today for a continuation of the uptrend.

2. 30-day Moving Average of the CBOE Equity Put/Call Ratio at Extreme Low
The 10-day moving average of the CBOE Equity Put/Call Ratio has fallen to 0.45, which means that the volume of trading in calls has been more than twice that in puts. So, investors are interested primarily in betting on further rising prices, not falling prices, and that’s bearish. The current reading is less than half the level it was thirteen months ago and its lowest level since the all-time peak of stock market optimism from January 1999 to September 2000, the month that the NYSE Composite Index made its orthodox top. The 30-day average stands at 0.50, the lowest reading since October 2000. It took years of relentless rise following the 1987 crash for investors to get that bullish. This time, it’s taken only 13 months!

3. VIX at Very Low Level
The VIX, a measure of volatility based on options premiums, has been sitting at its lowest level since May 2008, when wave (2) of ((1)) peaked out and led to a Dow loss of 50% over the next ten months. Low premiums indicate complacency among options writers. The quants who designed the trading systems that blew up in 2008 generally assumed that low volatility meant that the market was safe, so at such times they would advise hedge funds to raise their leverage multiples. Low volatility, however, is actually the opposite, a warning that things are about to change. The fact that the options market gets things backward is a boon to speculators. Whenever options writers are selling options cheap, the market is likely to move in a big way. Combined with the readings on the Equity Put/Call Ratio, puts right now are a bargain.

4. Investors’ Intelligence Reading at Extreme Low
In October 2008 at the bottom of wave 3 of (3) of ((1)), the Investors Intelligence poll of advisors (which has categories of bullish, bearish and neutral), reported that more than half of advisors were bearish. In December 2009, it reported only 15.6% bears. This reading was the lowest percentage since April 1987, 23 years ago! As happens going into every market top, the ratio has moderated a bit, to 18.9% bears. In 1987, the market also rallied four months past the extreme in advisor sentiment. Then it crashed. The bull/bear ratio in October 2008 was 0.4. In the past five months, it has been as high as 3.4.

5. Daily Sentiment Index at Extreme Highs
The Daily Sentiment Index, a poll conducted by Trade-Futures.com, reports the percentage of traders who are bullish on the S&P. The reading has been registering highs in the 86-92% range ever since last September. Prior to recent months, the last time the DSI saw even a single day’s reading at 90% was June 2007. At the March 2009 bottom, only 2% of traders were bullish, so today’s readings make quite a contrast in a short period of time.

6. Dow Dividend Yield Very Low
The Dow’s dividend yield is 2.5%. The only market tops of the past century at which this figure was lower are those of 2000 and 2007, when it was 1.4% and 2.1%, respectively. At the 1929 high, it was 2.9%.

7. Price/Earnings Ratio Still High
The price/earnings ratio, using four-quarter trailing real earnings, has improved tremendously, from 122 to 23 but 23 is in the area of the peak levels of P/E throughout the 20th century. Ratios of 6 or 7 occurred at major stock market bottoms during that time. P/E was infinite during the final quarter of 2008, when E was negative. We will see quite a few quarters of infinite P/E from 2010 to 2017.

8. Trading Index Very Low (TRIN)
The Trading Index (TRIN) is a measure of how much volume it takes to move rising stocks vs. falling stocks on the NYSE. The 30-day moving average of daily closing TRIN readings has been sitting at 0.90, the lowest level since June 2007. This means that it has taken a lot of volume to make rising stocks go up vs. making falling stocks go down over the past 30-plus trading days. It means that buyers of rising stocks are expending more money to get the same result that sellers of declining stocks are getting. Usually long periods of low TRIN exhaust buying power.

*http://fintrend.com/ftf/Articles/Investing/8_Technical_Indicators.asp (Robert Prechter, Chartered Market Technician, is the world’s foremost expert on and proponent of the deflationary scenario. Prechter is the founder and CEO of Elliott Wave International, author of Wall Street best-sellers Conquer the Crash and Elliott Wave Principle and editor of The Elliott Wave Theorist monthly market letter since 1979.)

Editor’s Note:
- The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
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