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Risky Pictures



First, thanks to my fellow Minyans for the suggestions on the pistachio problem. One pound per hour is clearly an unsustainable pace, if for no other reason then opening the shells begins to hurt your fingers after the first pound. Cowboy suggested I wash them down with a pound of ice cream "any flavor" but I suspect he might be trying to fatten me up for another "market." He is from Texas, you know. Meanwhile, I've switched to raw almonds (no shells).

Now, let's look at some more Bullish Percent stuff. For those who would like a refresher on the Bullish Percent concept go here.

Just as we can construct a Bullish Percent chart for the NYSE and Nasdaq, we can also separate stocks into their respective broad sectors and construct a Bullish Percent chart for each sector. And, just as the Bullish Percent charts for the NYSE and Nasdaq can give us a picture of risk in the broad market, the Bullish Percent charts for the individual sectors can give us a picture of risk in each sector.

The same levels, 30% and below = low risk, and 70% and above = high risk, apply to each sector, though each sector has its own personality. Semiconductors, for example, very often move coast-to-coast from the upper 70s to the lower teens and even single digits. Banks were as high as 90% in 1998. Aerospace, on the other hand, tends to top in the upper 60s.

Market commentators in the financial media sometimes refer to the market as "overbought" or "oversold", but what does that really mean? Unfortunately, they are almost never asked to elaborate beyond that simple declaration. For an active trader "overbought" will mean something entirely different than what it means to a position trader, and something different still to an intermediate-term investor, and so on.

Once you have identified your specific time frame then to me it seems more important to identify risk than to focus narrowly on pure overbought/oversold conditions. First, overbought can always become more overbought. Second, overbought within the context of lower-risk market conditions is much different than overbought within the context of higher-risk market conditions.

To get a more complete picture of market risk we find it helpful to take our individual sector Bullish Percent readings and plot them along a simple bell curve. Remember Statistics 101 from high school? Given a set of data, one can construct a range, which is depicted as a bell curve. There are six standard deviations on the bell curve. Three standard deviations to the left of mean, or center, is considered 100% oversold. Three standard deviations to the right of mean, the center of the curve, is considered 100% overbought. The middle of the curve is "normal" and most of the time sectors reside within one standard deviation of normal.

Below is a picture of our current sector bell curve through June 26, 2003.

As you can see the average sector reading is above 70%. That's extraordinarily high and paints a picture of very high risk in the market. We consider an average reading above 60% to be fairly high.

By comparison, let's look at a bell curve from March 17 of this year, just as our first indicators began reversing up.

That is quite a difference. The bottom line here is that inevitably the picture painted by the sector Bullish Percent bell curve will return to a more normalized distribution where some sectors are overbought, some are oversold, and the majority reside within one standard deviation of the middle of the curve. Important to understand, however, is that the only way this can happen is if stocks begin giving sell signals, and by definition causing near-term technical damage.

The market can hold on to dangerously high sentiment readings, and dangerously high risk indicator readings, for quite some time. Similarly, it turns out I can shell about a pound of pistachios an hour, but not indefinitely. Inevitably, there's a price to be paid.

No positions in stocks mentioned.

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