S&P 500 at 1,100—Time to Get Bearish?

On Nov. 4, during the second day of the Federal Open Market Committee meeting, I wrote about 5 Reasons to Buy the Market.

The S&P has since moved 6% higher, to 1,110 from 1,045 in eight days. So, is now the time to take profits? Many investors probably thought so last week as the market rallied up to the October highs and settled back below 1,095 marking some sort of potential double-top—or so they hoped, as they continued to sit on the sidelines, or worse, as they continued to short or sell upside calls.

But to fight this market is to hope against forces and multipliers of forces you don’t understand. It’s what I’ve been writing and talking about since July, and summed up in articles like S&P Rally to 1,100—Despite the Fundamentals  and The Bull Train You Can’t Catch.

Bernanke Reassures

When Big Ben spoke today before the Economic Club of New York, he gave us confirmation of two key drivers of recovery and asset reflation. First, despite all the handwringing about inflation, bubbles and exit strategies, the Fed will still remain accommodative for an extended period because they think it’s the right thing to do given the current economic circumstances. Any questions?

Second, not only are they carefully watching all the important data points on jobs, bank lending, housing and consumer health, they have many tools available to reverse the “extraordinary liquidity” of the past year’s policies. In other words, they still want to spark some inflation and are not sure we’ve got enough of it yet to risk removing stimulus from a still-fragile recovery.

The only knee-jerk reaction in any market was the euro as it dropped about 90 pips in 10 minutes in after the release of his prepared remarks. And true to currency traders’ hyper-sensitive form, the euro climbed right back as any mis-reading about the Fed getting ready to remove accommodation was, well, re-read.

Hightower and the Oldest Contrarian Indicator

When I interviewed David Hightower this morning and we discussed an indicator he’s been using for 20-some years to time the S&Ps, he humbly mentioned that he was the very first paid stock index analyst. Since he’s been at this awhile, this is worth listening to.

His indicator, the CFTC Commitment of Traders (COT) report, is bread and butter for futures traders. It details the positions of large traders, both commercial hedgers and speculators, as well as aggregate positions among smaller groups of non-professional speculators.

The most watched stat that comes from this data is the net position of commercial traders, which many analysts feel leads the market by two or three weeks. For example, if commercial positions are “net short,” indicating that more short futures contracts than longs are held among the pros, this could be considered bearish because the “big and smart” money is positioning for some trend change or acceleration. The caveat here, of course, is that the commercials are generally institutional investors such as pension funds and hedge funds that often maintain a net short position because of the way they use S&P index futures to hedge or manage existing risk.

The second most interesting stat we get from the COT report on the S&P’s is what the small speculators are up to. Dave pointed out that the “net spec long” position of essentially retail traders has risen to near 60,000, meaning that combined long and short positions come out with the longs ahead by that number of contracts. Is this a high number indicating wild speculation among retail traders and thus the ultimate contrarian indicator?

Not exactly. The highest “net spec long” we’ve seen from this group is about 110,000 bullish contracts in March of 2001. And confirming this indicator’s contrarian success we find that these traders were basically flat (longs = shorts) during the depths of the financial crisis at the end of 2008. To their credit, they did turn net bullish 80,000 contracts during the first half of 2009.

So, we’ll keep an eye on Hightower’s “Cab Driver Indicator” and see if it runs to a bullish extreme above 100,000. Given that the use of S&P E-mini futures has at least doubled since 2001, the bullish extreme could take us much higher.  See my full interview with David on our StreetSmarts segment posting on ONN.tv Tuesday.