The Real Issue Is Sentiment

 | Jul 11, 2018 | 6:00 AM EDT
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It is curious that when the market gets overbought along comes some sort of news that helps them relieve that overbought condition. Tuesday started with a weak Russell 2000 and just after the close we got news that the trade war is still on and might even be accelerating.

So whereas breadth had been leading last week, this week it has been lagging. For example, Tuesday's nearly 10 point rally in the S&P came with a flat day for breadth. Then we have the fact that the S&P is pushing up against 2,800, with the highest close since the January highs and the number of stocks making new highs can't get out of its own way.

I have been harping about the Nasdaq's new highs but the NYSE isn't exactly humming along. With nearly 200 stocks at new highs in early June and fewer than 150 new highs now.

The real issue is sentiment. Yesterday I noted that while it felt as though everyone around us had turned bullish the statistics did not agree. Namely the put/call ratio had remained elevated. Tuesday we got a small sign that there was too much bullishness when the Daily Sentiment Index (DSI) for the VIX chimed in a 9.

As a reminder when the DSI falls under 10 I consider that extreme. Typically a single digit reading will lead to a rally in the underlying instrument. In this case it means the VIX should rally and that typically means the market should go down. Okay, all of that makes sense, considering the overbought condition and the anecdotal sentiment we see.

The Investors Intelligence Bulls also moved back up. They were 47% just two weeks ago (and last week) but now they are 52.4%. That's a big jump for just one week.

Then we get the put/call ratio for equities at 74%. That is not a typo. We have just witnessed a decline in the month of June and the equity put/call ratio never got anywhere near 70% yet on the first day the Russell has some downside and yet the S&P is up nearly 10 points we see this indicator rise to levels not seen since early May. Does this make any sense to you?

Take a look at the chart of the S&P from the spring. There were six readings of the equity put/call ratio over 70% from late March through early May. All are indicated with green arrows on the chart. Only one has the S&P up on the day and at that, it's just barely, and after having been down all day (late April).

We typically see these high readings on down days, and typically after the market has been down for a few days. Tuesday's reading is very unusual. For now I think I'll stick with my call that we're overbought and in need of a pullback.

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