Woes May Linger, But Equities Maintain Overall Bullish Tilt

Are we going to have a fall fall? Is the market’s incredible five-year bull run over? Ever since the summer’s subprime smash-up, analysts and traders have been super-jittery. Some experts on market seasonality warn that the autumn is typically the most turbulent time for stocks. So is this week's weakness just a prelude to the great bear market, or should we expect the usual bounce into the Christmas season? Does the data in the latest Commitments of Traders report released last Friday help us find answers? Why, yes, I think it does, thanks for asking.

The COTs reports, which detail trillions in futures and options holdings in 100-odd markets, have warned for a few weeks to expect some market turmoil, but they’re still almost uniformly bullish for equities and Treasuries, suggesting even lower interest rates are likely. All my trading setups for equities are in bullish mode, with the solitary exception of the NASDAQ 100. That one flipped to bearish as of the Oct. 9 COTs report, due to excessive bullishness on the part of the “dumb money” large speculator crowd. These folks are the big investment firms and hedge funds, which the data shows tend to be wrongly positioned at market turns. In mid-October, they suddenly hit a historically extreme net long position, which my system tells me is a warning sign that a market trend has a high chance of changing.

On the other hand, my setup for the S&P 500—based on trading opposite to the “dumb money” small traders—flipped to bullish with the Sept. 25 COTs report. The wrong-way crowd put on its largest net short position in 12 years as a percentage of the total open interest. The small traders have since slightly reduced their net long position, but remain highly bearish nonetheless, signaling more market gains are likely.

I’ve also developed a COTs U.S. Equity Composite Index based on four of my equity setups. This indicator has been in bullish mode since March. Interestingly, it remained bullish even during last summer’s correction, rightly suggesting that the selloff would be short-lived. Since hitting a high of 1.22 in late September (a reading of “1” or higher means all four setups have just given a bullish signal on average), this indicator has fallen steadily to 0.17 as of last Friday’s COTs report. I take this as a warning that the market’s weakness may not yet be quite over. Nonetheless, the indicator remains above 0, so I still see the data as showing a slight bullish tilt.

As for the Treasuries, all of my setups in this area are now bullish (meaning they’re calling for rates to fall). Falling rates should in turn be positive for equities in some measure—although they could also signal the bond market’s expectations for economic weakness. That, ultimately, may not be so bullish after all in the longer run.