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Hello Fellow Chart Watchers! The year-long increase in Commodity prices appears to have finally caught up with the stock market. Sure, unrest in the Middle East and some so-so earnings reports didn't help the situation - especially on Thursday - but a very important component of last week's unrest can be found on our Intermarket PerfChart where the S&P 500 and the CRB Index diverged significantly for the first time since June 1st.  For much of the summer, stocks and commodities moved pretty much in tandem. Notice that from June through early October, there are few times when the red and blue lines moved in opposite directions. All of that changed at the beginning of last week when commodities - driven mostly by energy prices - diverged more than 9% from stock prices. On Thursday, the CRB Index hit its highest level in over 2 1/2 years.  When stocks and commodities are moving in tandem, it usually signals an unhealthy, imbalanced market situation. Investors should be cautious as short and medium trends often lack conviction and the long-term trend may be in the process of changing direction. Now that stock and commodities appear to be moving in opposite directions, we can start to believe in the market's trend again. And just what is that trend right now? Despite Friday's big reaction rally, the negative signs still outweigh the positive ones:  3.) The ADX line for the S&P 500 has risen to its highest point (33.7) this year and the -DI line is above 30 right now indicating that a very strong downtrend is underway.  My current conclusion? A mid-to-long term downtrend has started and is gathering strength. Be careful out there. Later on, Arthur Hill looks at two sentiment indicators that may be giving more encouraging signals. But first...
  On StockCharts.com right now:
Measuring Market Sentiment Market Sentiment indicators are contrarian in nature and seek to identify periods of excessive bullishness (complacency) or bearishness (panic). Too much bullish flavor may foreshadow an imminent market top and too much bearish flavor a market bottom. The contrarian logic behind sentiment indicators makes perfect sense. Those who are bullish have already bought and those who are bearish have already sold. If too many people have already bought (sold) then there is nobody left to drive prices higher (lower). There are many ways of measuring market sentiment. Barrons publishes statistics to show the percentage of bullish and bearish market advisors. Other sites use market polls to gauge investor attitudes towards stocks. Two of my favorite sentiment indicators come from the CBOE: the Volatility Index ($VIX) and the Put/Call Ratio ($PCP). The $VIX measures the implied volatility of the S&P 100 options using a basket of puts and calls. The higher the volatility is, the higher the perceived risk in the S&P 100. I usually apply a 10-day simple moving average to smooth the indicator. When the 10-day SMA moves above 30% it is a sign of excessive bearishness (panic) and moves below 20% indicate excessive bullishness (complacency). The Put/Call Ratio is simply total put volume divided by the total call volume. This includes all index and stock options. The ratio typically hovers around .50, meaning there is 1 put traded for every 2 calls (1/2 = .50). When the ratio starts to advance towards 1, it signals that put volume is increasing relative to call volume and bearish sentiment is growing. I have not found the Put/Call Ratio that great for identifying market tops, but it can help with market bottoms. When the 10-day SMA exceeds .60 for an extended period of time, it indicates excessive bearishness. On the other hand, when the 10-day SMA is below .45 for any length of time it indicate excessive bullishness. When investors and traders start exhibiting signs of extreme panic or complacency, it can signal a turn in the market. However, this does not mean it is timely to buy at the first sign or panic or sell at the first sign of complacency. Even though market tops can form quite quickly, market bottoms usually take longer to manifest themselves. As the attached chart shows, the $VIX surpassed 35% (panic) on at least three separate occasions in April and May before the S&P 100 finding a bottom. The most recent S&P 100 top formed quite quickly though and the $VIX was below 20% (complacency) for a relatively short time period before turning up. Most recently, the $VIX surpassed 35% this past week. But, as the previous April/May indicates, there could be another round of panic and the S&P 100 may need more time to find bottom.  Here are some links that should help you get started:
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