Spike Higher?

[5/1/07] Major stock market tops are characterized by elation, ecstasy, and euphoria - not the fear of falling prices. We believe the combination of a fairly vibrant stock market and rising levels of fear is bullish for stocks, as sentiment gauges are best read from a contrarian perspective. We would use the bear's misguided feeling to our advantage.

One way to gauge market sentiment is to watch the short-interest ratio on the New York Stock Exchange. First, the short-interest ratio is the number of shares sold short divided by average daily volume. This is often called the "days-to-cover ratio" because it tells - given the stock's average trading volume - how many days it will take short sellers to cover their positions. Short sellers are, of course, betting on a price decline.

Since 1994, the NYSE short-interest ratio has oscillated between 3.7 and 7.5. The higher the ratio, the more investors are betting on a market decline. The lower the number, the more investors are looking for a rise in stock prices. The average ratio over this period has been 5.4. We view readings of 6 and above as bullish and readings of 4.6 and below as bearish. The current NYSE short-interest ratio is 7.4, or right near the top of the range since 1994 and just below the all-time high of 7.5 in October 1996.

With the ratio very high once again, and the market doing relatively well, the bears must have a case of severe indigestion and will, in all likelihood, be forced to cover their mistakes at even higher prices, adding more fuel to the fire.

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[4/4/07] Mark Arbeter, S&P Chief Technical Strategist, sees a higher market.

It's not often we predict a spike higher. That fraternity of market mavens who, among other non-bull's-eyes, have called nine of the last six recessions is just not where we'd care to be.

That said, certain technical measures we follow suggest higher prices could be in store later this year.

We're talking about the put/call ratio, which tracks options contracts purchased on the Chicago Board of Options Exchange. Puts are, of course, options to sell; calls are options to buy. The ratio is used widely as a gauge of market sentiment. When there are more calls than puts, Mr. Market is bullish. More puts than calls, and Mr. Market is bearish.

Recently this measure hit an all-time high, suggesting Mr. Market had just taken a room at the Bates Motel — a glut of fear, in other words. Interestingly enough, this occurred during what was by historical standards a relatively modest pullback. This excessive fear is, we suggest, bullish.

And so on.