Bulls Showing Fear

 | Oct 14, 2011 | 6:45 AM EDT
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Well, that wasn't much of a pullback, was it? So far the market has been moving sideways to digest the overbought reading. In fact, what I thought was interesting was the sentiment factor. I realize I have harped on this topic for days, but this market has become quite emotional.

The raging bulls from early this week found themselves scared with the S&P 500 down 1%. Think about that: Everyone who was bullish had been dying to buy the dip, yet when they got the dip, they got a little scared. What should be watched in the coming days is the put-call ratio. It has still not gone under 100% since Sept. 19. The lowest it has been since then is 103% on Sept. 26 (just prior to that last tumble). Thursday's reading was 105%.

We care because true up markets turn folks bullish -- but I find that, more often than not, folks turn even more bullish from markets that don't go down! That means we might just see some real giddiness creep into the market in the next few days.

But that is short-term stuff. Let me note that, on a more intermediate-term basis, the Investors Intelligence readings still show too many bears at 46%. Still, I expect next week we will see a decline in this reading. In addition to that, the 10-day moving average of the put-call ratio is still sitting up at its highs, and any lower readings should send it lower. This, too, would be considered bullish.

Put-Call Ratio

In the shorter term, the number of stocks making new highs on the Nasdaq continued to contract. I realize everyone is very excited over technology -- I even wrote a positive mention on the Philadelphia Semiconductor Index (SOX) last week -- but this must improve. Otherwise, once again this rally will be too narrow an advance, similar to what we saw last summer. Again on Thursday, there were fewer stocks at new highs.

Number of Stocks Making New Highs -- Nasdaq

The biggest challenge to this market is the volume, since these numbers are truly pathetic. The Nasdaq has tacked on 5% to 6% this week alone, and not one day has volume been at more than 2 billion shares. Step back and take a look at the chart below. You can see this week's volume is similar to the two red boxes on the chart. Would it surprise you to know that Box A was the rally in the final days of June and early July, and Box B is the rally in the final days of August?

Volume -- Nasdaq

The key will be whether sentiment starts to turn much more bullish, if the volume stays lousy and if new highs don't expand.  For now stocks are simply overbought.

I have been asked by several about the potential head-and-shoulders bottom I'm seeking. Take a look at a chart such as Peabody Energy (BTU). Doesn't this pullback from $40 over the last two days look like it could be forming the right shoulder of a head-and-shoulders bottom?

Peabody Energy (BTU) -- Daily



Overbought/Oversold Oscillator -- NYSE

Overbought/Oversold Oscillator -- Nasdaq

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