After Massive Rally Off March Lows And Options Waiving Caution Flag, Johnny-Come-Latelies Risk Holding The Bag

If so, from bulls’ perspective, there are tons of bears that are yet to jump on the bullish bandwagon. Amazingly, in the week to May 7, AAII (American Association of Individual Investors) bears were 52.7 percent. By then, the S&P 500 had already rallied north of 31 percent off of the March 23, low. Yet, bearish sentiment was the highest since April 2013 (Chart 5). 

Since the high two weeks ago, bearish sentiment has dropped a bit, with last week at 45 percent, but remains very high – comparable to August 2010, February 2016 and December 2018 highs. Back then, stocks rallied nicely once bearish sentiment began dropping on a sustained basis. Bulls are hoping things evolve similarly this time around.

In this scenario, it is only a matter of time before the S&P 500, and other indices, break out of their recent range. If 3000 decisively falls on the S&P 500, stops get taken out and shorts likely move out of the way.

Then what?

As explained earlier, indices have had massive rallies from the March lows. The Nasdaq 100 is merely 3.4 percent from its February 19, record high, while the S&P 500 is 14.8 percent from its. Several indicators have rallied to overbought territory. Some are extremely overbought.

The percent of Nasdaq stocks above the 50-day last Thursday rose to 83 percent, before dropping a tad on Friday to 82.6 percent (Chart 6). Thursday’s reading was the highest since May 2009. Tech has been a leader, no doubt. But the action does not line up with the AAII bearish sentiment.

Neither does the CBOE equity-only put-to-call ratio. In the first three sessions last week, readings were in 0.40s, followed by 0.50s in the remaining two. Granted it was a week in which the S&P 500 rallied 3.2 percent, prompting bullish option activity. At the same time, sentiment has leaned bullish for several weeks now.

On February 19, which was the day the S&P 500 peaked, the 10-day average of the ratio printed 0.501. Leading up to this, it dropped as low as 0.48 on January 17, a nine-year low (arrow in Chart 7). Greed was extreme, the unwinding of which resulted in the February-March selloff in equities, leading to the spike in the 10-day to 0.989 by March 19. Fear was palpable then. Now, the pendulum has swung the other way. Last Thursday, the 10-day ratio dropped to 0.554, with Friday at 0.557. This is frothy territory. It is too soon to say if Thursday’s marks a bottom. In a scenario in which the S&P 500 takes out 3000, the 10-day ratio likely gets frothier, which by the way is what equity bulls are shooting for. But the lower the 10-day goes, the higher the odds the Johnny-come-latelies in particular, will be left holding the bag.

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