Market Update: Winning Streak Ends, How Long the Losing Streak? Well, the six-week winning streak for the market came to a close, barely. The S&P 500 closed about 3 points under last week's close, but it likely would have been much worse had most banks not passed the government's ridiculous 'stress test'. Though the weekly loss is 100% attributable to Monday's big dip, I still contend - as I did earlier in the week - the market was going to have to face this necessary evil sooner than later. That said, I don't think the worst is over yet.  We'll look at what I mean below, but I also wanted to use today's edition to close the contrarian/sentiment can of worms I opened on Monday. The sentiment charts I mentioned I watch on a regular basis? I've added some of them below.    It's Been a While In The Making You don't have to be a 30 year trading veteran to look at a chart and recognize that while the market was rising over the prior six weeks, the pace of the move was slowing each week.  Sometimes the downshift is only a temporary move, and stocks accelerate again before all the momentum dies. The majority of the time though (like now), the bullish momentum completely dies, and needs to 'reset' before being renewed. If you're more of a trading scientist - as I am - you can alternatively apply a tool like the moving average convergence divergence indicator (or MACD) to come to the same conclusion. Though I'm not a particular fan of MACD because it's prone to a lot of false signals, this week's bearish cross wasn't one born strictly out of volatility.... it's been a while in the making. In other words, I'm taking this week's decline at face value, and looking for a little more downside in the near future. How much downside? Don't worry - I'm still a bull in the long-term.  As I mentioned a couple of times in prior newsletters, the ideal landing spot for a pullback would be the first major Fibonacci retracement line around 797; that hasn't changed. In the meantime I've been studying about previous bear market bottoms, and have been forced to accept the likelihood that the first major dip of a new bull market could cut more deeply than a mere pullback to 797. Without getting too deep into the details, the way the market (I'm using the Dow as my proxy) hit a major bottom in 2002 and 2003 is actually a fairly typical start to most new bull markets. That bottom occurred in October of 2002, stocks flew off the low, and gained about 23% over the next 50 days. Sound familiar so far? It should. Then, from late November all the way through March of 2003, the Dow gave up the bulk of its October/November gain, coming within striking distance - within only a few percentage points - of the October low before ultimately recovering on a more permanent basis. As it turns out, more than half of all our previous bull markets start out the same way.... with a huge rally at the onset, and then a frightening return trip almost to the prior low (and in some cases, all the way to the prior low). In comparing today's chart to 2002/2003 as well as the 'norm', I can't help but wonder.  In some regards I wish I hadn't done the study, though I guess in retrospect I'd rather know my odds than not.  There's an upside to all this though, if your confidence really, really needs to not see the majority of our recent gain wiped away... a decent number of new bull markets didn't give up the majority of their first bullish waves. It's safe to say you guys are in the S&P 500's "retracement to 797" camp.  I'm not in the same camp with you, though I'm prepared to join you if for some reason the 797 area holds up as support. In the meantime, I'll probably be planning for a full retest of March's lows. Hope I'm wrong. P.S. For the S&P 500, the resistance at 875 is still a trump card. If it breaks we may see a strong upside run. It still won't negate the likelihood of a major pullback though.   Put/Call Ratios, In Living Color I only mentioned them in passing last time around, but the idea of comparing the daily trade volume of bearish put options and bullish call options as a sentiment indication prompted a lot of great questions from you guys. So, I'm going to show you exactly what I'm talking about today. Let's just start at the beginning. Like I said on Monday, nominal or indecisive sentiment (or opinions) don't mean much, but when sentiment hits an extremely bullish or bearish level, as a contrarian, I start betting the other way. I've posted a chart of the VIX as well as a chart of consumer confidence in the past, which I use as short-term and long-term contrarian tools, respectively.  What I didn't show you on Monday were charts of two of my other favorite sentiment indications.... the CBOE put/call ratio (equity only), and the ISE put/call ratio. These two indicators are considered sentiment indicators because they tell us how bullish or bearish options speculators are.  Like I said then, the raw daily data of both indicators has just become too erratic to tell me anything anymore. I have, however, found that different moving averages of either data can tell me a great deal about when sentiment has peaked or bottomed... which usually occurs as or before the market turns. The nearby chart shows you what I mean in vivid color. The top part of the chart is the S&P 500; the bottom part is where you'll find the put/call ratios I watch.  The actual put/call ratios are plotted in gray, and as you can see are just too volatile from day to day to effectively 'read'. The put/call ratios' two moving averages (red and blue) and their crosses (highlighted in yellow) are what I'm interested in watching. And sorry, I can't tell you what moving average lengths I'm using - I've got to keep some trade secrets. More importantly though, we can these moving average crossover coincide with the bigger shifts in the market momentum. So, I'll repeat what I said on Monday.... I use contrarian tools because they work far more often than they don't.  I'll update the put/call ratio charts in one of next week's editions.   Just to Clarify... By the way, after we sent out this week's earlier newsletter, a couple of our readers pointed out the sentiment indicators we were reviewing were not necessarily leading indicators, but rather, coincidental indicators (which don't 'predict' the market but rather ebb and flow with it). It's a discussion worth having here. On the surface, yes, most sentiment indicators appear to just be coincidental indicators... and many of them are nothing more.  However - and as you can see with our chart above - when interpreted in a certain way, sentiment tools can decisively tell you which market trends have longevity or not.  Take any of the three major swings on our chart as an example. The S&P 500's chart was very erratic in all three cases, and using it alone to judge the market's momentum probably would have resulted in a large number of fake-outs.  Had you simply used the put/call ratio moving average crosses as your buy/sell signal though, you would have continued to ride the bigger trend, and not been spooked out of a good swing trade just because of a little daily volatility... those moving average crosses tend to last for the duration of a trade-worthy trend. That's not to say sentiment tools are bulletproof; they're wrong sometimes too. They're right a heck of a lot more often than most other tools are though, because most major reversals start or end with a peak in fear or greed. In other words, the greater the anxiety, the bigger - and longer - the reversal generally is. Minor, lethargic reversals just don't cause the same kind of anxiety.  Our interpretations are intended to remove the coincidental aspects of sentiment data, and highlight those important peaks in bullish or bearish opinion. Hope that helps explain how we view the contrarian idea.