SENTIMENT JOURNAL: Sell In May?
By Frederic Ruffy, Optionetics.com
5/23/2003 11:00:00 AM
Market Internals: After Monday’s 185-point plunge, the Dow Jones Industrial Average ($INDU) steadied on Tuesday and began a gradual climb higher (through Thursday). Market internals improved as trading progressed. For instance, the ratio of advancing to declining issues, which was more than two-to-one negative Monday, ameliorated. As we can see from the Market Data table above, advancing issues trailed declining issues Tuesday, the trend reversed Wednesday, and by Thursday, the ratio of advancing to declining issues was two-to-one positive. The ability for the stock market to recover from the sharp sell-off Monday, and for internals to strengthen as the week progressed, is a sign of a healthy trend.
The Nasdaq Composite Index ($COMPQ) fell during five of the past seven trading sessions. In the latest week, the Nasdaq gave up roughly 30 points or 2% (although Friday’s numbers were not in at the time of this writing). Heavy losses occurred Monday, when the Composite index dropped 46 points, or 3%. From that point forward, the situation stabilized and market internals improved. By Thursday, up volume led down volume by a three-to-one margin and the ratio of advancing issues to declining issues was five-to-three positive. The question will be whether market internals can continue to improve as traders come back from the Memorial Day holiday and trading volumes increase once again. Technical traders will also be watching to see whether or not the Nasdaq Composite can hold the 1,500 level.
Sentiment Data: There is an adage on Wall Street that says, “sell in May and then go away.” The logic behind this little ditty is that October to April tend to be the strongest period for stocks, but May to September are the weakest. Therefore, it is better to sell or trade the market to the downside beginning in May. In addition, the month of May was a pivotal moment for the stock market last year. During that month, stocks started slipping and volatility began to rise. The trend continued until late-July. From the end of May until July 23, the CBOE Volatility Index ($VIX) surged from 23% to over 50%. Many option traders are naturally wondering if volatility is once again set to rise as we move into the month of June.
Predicting changes in volatility is quite simple when compared to, for instance, computing the radius of the North Star, but it is not always a straightforward endeavor. There are certain factors to consider and one is the prevailing market sentiment. If the majority of investors, or the crowd, are predominantly bullish or complacent, the chances of increasing volatility become higher. At that point, the majority of investors have already bought shares and they are more inclined to sell in the event of unwelcome and unexpected news.
Over the past few weeks, we have noted here that the sentiment data is showing the type of complacency and bullishness that has characterized previous market tops. During the past week, however, there has been evidence of rising bearishness. For example, the CBOE put-to-call ratio has risen above 1.00 during all four trading sessions. Such a series of high readings are relatively rare and suggest a high proportion of put activity relative to call volume, which is also an indication of a high level of bearish sentiment. Thursday, the ratio jumped up to 1.16 and to its fourth highest reading of the year. The increase in the ratio is a clear sign that options traders are becoming more cautious and are beginning to hedge bets in case, just like it was last year, the month of May turns out to be a major turning point in the market. In addition, as we can see from the Sentiment Indicators table below, the index put-to-call ratio also spiked higher. It rose to 2.70 Thursday. Readings of 2.00 plus are generally considered a positive omen for the stock market.
Not all indicators are pointing to rising levels of bearish sentiment, however. The CBOE Volatility Index ($VIX remains at low levels. As a result, the market’s so-called “fear gauge” is reflecting very few signs of market angst. The latest surveys of investor sentiment from Investor’s Intelligence are now showing 56% bullish (from 54.4% a week ago) and only 20.9% bearish (and down from 23.9%). Finally, the put volume indicator [PVI], which rises towards 2.00 when investors are extremely bearish, fell to .85 as put activity declined sharply Wednesday.
Overall, then, from a sentiment perspective, bearish sentiment is rising after falling to very low levels. There is every reason to expect that bearish sentiment will continue to increase as a number of indicators are still showing relative bullishness or complacency in the market. If so, it would be natural to assume volatility will increase as we move into the summer months and out of the month of May.
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