Bernie Schaeffer: "Wall of worry is still very present"

As I've pointed out in this space more than once, the 2007 stock market has been wrought with caution, bearish hedging activity, and pessimism, despite the fact that the major market indices have remained in positive territory for the year. This makes the entire expectational landscape notably different from some tenuous bull markets of the past, when complacency, contentment, or even euphoria ruled the roost. This past week's action, with the Fed decision and the subsequent market pullback, verified that a wall of worry is still very present in this market, which is reinforced by some oversold technical readings that are normally associated with serious bear markets as opposed to bull market pullbacks.

In Thursday's trading, the Desmond 90/90 Indicator showed up, indicative of a panic in the trading crowd. This reading simply means that 90% of volume and 90% of price action is negative. While not easy to stomach on a day where this transpires, a negative skew of this magnitude can mark a market turning point, as recent data from our Quantitative Analysis group show.

Another indicator we follow that reached a bearish extreme is the TRIN (Traders Index) – also called the Arms Index - which registered a 2.99 reading on Thursday. This indicator measures the relative volume on declining vs. advancing stocks, and readings well in excess of 1.00 as registered on Thursday imply extreme oversold conditions.
Finally, Thursday saw odd-lot short selling (short positions of fewer than 100 shares per transaction) move to its highest daily reading since August 16, 2007. As you probably remember, that day proved to be a short-term market bottom as a panicked urge to sell off any and everything corrected itself with a renewed buying trend.

And it's not just small-time traders with trepidations toward the market. The latest Barron's Big-Money poll just published this weekend shows there has been a drop in bullishness among professional investors. In fact, 47% of those responding to the financial weekly's survey say they are bullish about the outlook for stocks through the middle of 2008. This is well below the 64% "bullish" reading from last fall's poll. Furthermore, a hedge fund manager survey from Greenwich Alternative Investments revealed that 50% of respondents were bearish as we moved into November. Over the past couple of years, such elevated levels of bearishness from this group has preceded strong market action.

This cautious sentiment, the propensity for the market to quickly reach oversold levels, bullish fourth quarter seasonality and the bullish implications of the third year of a presidential term all have me feeling sanguine about a bullish trend perpetuating through the end of the year. While there have certainly been some major blowups as financial engineering met financial reality for mega-cap names such as Merrill Lynch (MER) and Citigroup (C), pure consumer financial play MasterCard (MA) posted blowout earnings and the stock proceeded to soar. And the "meat and potatoes" economic news is far from grim.

~ Bernie Schaeffer, Schaeffer's Monday Morning Outlook, November 5, 2007