Investor Apathy Means the Market Stays Bullish

I'm looking for signs of a market top, something . something. Not that I'm nervous, mind you. Actually, I feel quite comfortable being long. I've been strongly bullish since May, and in the first week of June, I sent a Special Update to the subscribers of my Economic Contrarian Update advising them to "Buy the Zarqawi dip."

I know that sounds funny to hear now, but it wasn't so funny four months ago. Back then, many people felt that taking out the top terrorist in Iraq should have triggered an instantaneous, jubilant response in the market. When it didn't happen, the bears were out in force. To a veteran trader like me, that sell-off was a gift, and my mother always taught me never to refuse a gift, so naturally I bought more.

Investors are so impatient. They let their impatience blind them to opportunity and to reward. I often wonder why that is, because it's so self-defeating. Remember the four behavioral traits necessary for success? Patience is the first, followed by alignment, detachment, and discipline. I call it the P.A.D.D. system. Without these four behavioral attributes, you won't make it as an investor or trader. I don't care what kind of methodology you use: growth, value, top down, bottom up, technical, fundamental, astrology, numerology, whatever -- it doesn't matter. It's the behavioral part that always separates the winners from the losers.

As a contrarian, I like to look at the behavior of the crowd and determine their mood and their sentiment. This will alert me to whether or not the market is at a major peak or at a major trough. The fact that the Dow just made a new record high doesn't suggest we're dealing with a major trough (at least as far as the Dow is concerned), but what about a major peak?

To help answer that, I turn to my indicators. They're the ones I use to get a handle on investor sentiment and psychology. In particular, I want to see whether there are any signs of frothiness or bullish exuberance. I use things like the put/call ratio, volume trends, and evidence of widening coverage of the market in the mainstream media.

I'm here to tell you that none of the aforementioned is flashing any warning lights, red or yellow. In fact, you could almost say that the new record high in the Dow was met with total ambivalence.

Take a look at the put/call ratio. Generally, a high put/call ratio means that investors are more cautious or worried. Not surprisingly, high put/call ratios often coincide with big market rallies because investors' fears have largely been discounted into the market. What hasn't been discounted, though, is the return of "good times," and when the good times come (and they inevitably do), a lot of buying develops. Conversely, the opposite is true at market tops: At tops, put/call ratios tend to be low (along with investors' fears). Then the economic outlook suddenly weakens, along with profit expectations, and there's a sell-off.

Last Wednesday, the Dow finally settled at a new, all-time high, eclipsing the old record set six years earlier. On a day like that, you'd expect the put/call ratio to be at a record low or somewhere near there. I would. But nothing of the sort occurred. The ratio came in at 1.18, which is fairly high, given the new milestone the index had achieved.

I know that some of you who are a bit more sophisticated might be saying, "Yeah, but that put/call ratio stuff is misleading because it only reflects put volume divided by call volume. Nowadays, with the proliferation of covered call writing and other sophisticated options strategies, it's possible to have a big up day in the market and a high put/call ratio and vice versa."

You're absolutely right. That's one reason why I like to look at a smoothed version of the daily put/call ratio, which is the 30-day average of it. This tends to minimize the impact of days when a big investment bank, hedge fund, or some other trader is selling a huge volume of puts on a big down day, for instance (playing for a bounce).

When I looked at the smoothed version, guess what I found? Despite the record-setting performance of the Dow, the 30-day average of the put/call ratio remains pretty high. It's hovering near the highest levels in a year. To me, this isn't indicative of a market bubbling over with bullish enthusiasm. If anything, it still suggests that investors are cautious.

In addition to the put/call ratio, I like to look at volume for information about sentiment. So far, nothing that I see in the volume data suggests a top right now. After a sustained move up such as the one we've had (which included a major average crossing into new record territory), I'd expect to see volume expand significantly. It would be saying that investors were exhibiting an urgency to get into the market, that they were starting to fear not being involved in this rally. And by corollary, if everyone got in now, it could mean the top -- at least for a while.

However, the exact opposite is true. Just take a look at the numbers: In the past month, the average daily volume on the NYSE was 2.5 billion shares. During the same period one year ago, volume averaged 2.4 billion shares. So in terms of the volume comparisons, there's hardly any difference. On the other hand, the Dow is now 1,400 points higher.

In the past four months, there were two days that I guess you could call "volume spikes." September 15 was one those days, when 3.2 billion shares were traded. The other was June 8, when 3.4 billion shares were traded. Neither of those volume spikes has been surpassed, not even on the day that the Dow achieved its new record high close (2.68 billion traded -- ho hum).

In contrast, in the lead-up to the market top in 2000, average monthly volume swelled to nearly three times that which was seen a year earlier. It became like a huge tidal wave of buying, which ultimately crashed. The current wave we have now is miniscule, if there is one at all. There will be, though. Believe me, there will be.

Finally, no analysis of market sentiment would be complete without examining the media's take of what's going on. Of all my indicators, I've long considered this to be one of the most important. I wrote a column back in May entitled "Spotting the End of a Trend," which dealt with the media and the markets and how investors can use the media to spot major turning points.

Anyone who was around in March 2000 doesn't have to be reminded about all the intense coverage of the stock market. It was incessant, it was pervasive, it was in your face, and it was completely over the top. CNBC reporters were being treated like A-List Hollywood celebrities, and non-business media outlets were running business stories constantly. Admittedly, this had been going on for some time, and one could have called "the top" several times prior to the real thing by simply watching the news coverage. However, there's no way to say there weren't warning lights flashing -- first yellow, then red. You had time to get out.

In contrast, consider the Dow's recent new record. On Oct. 4, one day after hitting that mark, the world's most famous index barely achieved mention in one of the world's most famous newspapers -- The New York Times. The paper did recognize the event by running a story on the left-hand column of its front page (a spot usually reserved for stories of lesser importance, whereas the right-hand column or headlines across the top are reserved for really important stories), but one got the sense that the paper did it almost out of obligation rather than it being anything newsworthy.

Even if I'm wrong about the placement of the Times' piece, it doesn't matter because the Dow's comeback was muted in the media, even ignored to a large degree. Certainly, this isn't the stuff tops are made of.

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Fool contributor Mike Norman is the founder and publisher of theEconomic Contrarian Updateand a Fox News Business Contributor. He's also a radio show host at BizRadio Network.


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