The broad market bounced back in a major way last week, with all four of the major market indices gaining more than three percent. The S&P 500 Index (SPX) not only conquered the 1,400 level once again, but it is now less than two percent away from the peak of 1,461.57 it reached just before the sharp pullback that started on February 27. In addition, the SPX is now sitting on a 1.3-percent year-to-date gain.
While the market now appears to be on the mend again, analysts around the Street have begun to complain about the relative shallowness of the recent pullback and the brevity of the consolidation phase. From peak to trough, the SPX shed only 6.7 percent and has staged a rather quick bounce back.
This bounce has not been met with celebration and general jubilant comments, but rather with a strong does of skepticism from both Wall Street and investors alike. Last week, the latest short-interest figures were released by the New York Stock Exchange (NYSE), revealing a 9.5-percent jump in the shorted shares not yet closed out on the NYSE. The monthly period measured for short interest stretched from February 15 through March 15, encompassing the pullback in the market. Even so, this is an off-the-charts increase in short interest, as my experience has been that these monthly short-interest changes tend to be in the one- to two-percent range.
A second sign of the growing pessimism on Wall Street comes from mutual fund investors. Recently, the NAVî šdjusted assets for the Rydex Nova fund has plunged to a more than three-year low as investors have fled the mutual fund. The Nova fund is designed to have a target beta of 1.5. In other words, using shares of equities, stock index futures contracts, and options on those securities and futures, the fund has a target performance benchmark equal to 150 percent of the SPX. Traders who invest in this fund are considered very bullish on stocks.
A final sentiment indicator that is pointing toward extremely heavy levels of pessimism is the Schaeffer’s equity put/call open interest ratio, which measures put and call open interest across all equities using their front three months of options. This ratio has soared to its highest level in more than four years, as put positions have been added at a faster pace than call positions during the past couple of weeks. In fact, this ratio is near the highs achieved in 2002 when the market was searching for its ultimate bottom at the tail-end of a multi-year bear market. I find some very bullish contrarian implications in the fact that this major level of negativity was generated among equity option players by a pullback this brief and this shallow.
This mix of pessimistic murmurings from traders and Wall Street analysts suggests that there is ample money still waiting on the sidelines to help fuel a continued rally in the broad market.
Throughout this rebound in the broad market, the strongest performer has been the small-cap Russell 2000 Index (RUT). Last week, the index was the big winner as it gained almost four percent and is now up 2.8 percent on a year-to-date basis. The RUT easily plowed through resistance at the 795 level (a 50-percent correction level of the index’s recent pullback) and the 800 level, which hindered its rally attempts in December and January.
Looking at the iShares Russell 2000 Index (IWM), we find that peak April call open interest lies at the 82 strike, with roughly 81,000 contracts in open interest. Of course, this accumulation pales in comparison to the 258,000 puts at the April 76 strike or even the 123,000 puts at the April 78 strike. Meanwhile, the April open-interest configuration for IWM shows extremely light open interest above the 82 strike. Normally on a pullback like we had recently you will get an out-of-the-money call build. Not this time. This lack of interest in out-of-the-money calls on IWM indicates that traders are not expecting much more upside out of the small-cap sector despite its impressive technical performance.
Furthermore, anecdotal sentiment during the most recent “turmoil” in the market was that investors should play the safety of large caps, given the uncertainty surrounding the economy and interest rates. Yet, the market proved once again that rallies will be led by the small and mid-cap groups, again defying the consensus opinion that seems to favor the larger-cap, blue-chip names.
Finally, it is of interest to note that the SPX is currently sitting right at a level that corresponds to its peak on the morning of February 27, just ahead of that afternoon’s horrific plunge. The current rally stalled out at this level beginning on Thursday and we’ve moved sideways since then. This resistance (resulting from the fact that many players who did not sell ahead of the 2/27 plunge view it as a “break even” level from which to exit) may continue to weigh on the market over the short term.
As we close the final week of the quarter, the economic calendar will give investors a lot to digest before looking ahead to first-quarter earnings reports in the second week of April. Traders will be keying in on data such as new home sales, retail sales, and durable goods order for February in the first few days of the week. Later in the week, we’ll see final data for fourth-quarter Gross Domestic Product (GDP) and corporate profits, personal income and spending, the Chicago Purchasing Managers Index and construction spending.
