Did The Market Bottom?

Was Friday’s midday reversal the bottom? Or was the selloff into the close a bad sign of more damage to come? Ever since the summer’s subprime smash-up, analysts and traders have been super-jittery about the markets. Sometimes, all the technical indicators in the world don’t help us get a sense of where the market’s going. Some technicians are now quite sure we’re just at the beginning of the “fall fall”—and even a bear market. Others are just nervous.

It’s at times like this I’m thankful for the Commitments of Traders reports. These are the reports issued for free each week by the U.S. Commodity Futures Trading Commission that detail trillions of dollars in holdings in futures and options markets—everything from the S&P 500 to the Nikkei, crude oil and gold. The raw data is hard to interpret and has stumped leading economists and traders for years. But I’ve figured out a way to get statistically robust trading signals from the data based on when traders hit specific tested extremes of bullishness and bearishness.

The COTs have been warning for a few weeks to expect some market turmoil. Nonetheless, I see the data as being still almost uniformly bullish for equities and Treasuries.

The latest COTs report issued Nov. 9 has my trading setup for the S&P 500 still in bullish mode. This is based on trading opposite to the “dumb money” small traders when they hit historically extreme net positions. Alas, the little guy—you and me—is usually positioned the wrong way when the markets are about to turn. In the Sept. 25 COTs report, the wrong-way crowd put on its largest net short position in S&P 500 futures and options in 12 years as a percentage of the total open interest. Thus, my setup flipped to long and I bought myself a chunk of the 200-percent leveraged Ultra S&P 500 ProShares Fund (SSO).

Since September, the S&P 500 small traders have slightly reduced their net short position, but they nonetheless remain highly bearish. I believe this means a market bounce is more likely than a fall fall.

Also bullish: with the Nov. 9 COTs report, my U.S. Composite Equity Index has bounced a little to 0.19 from last week’s 0.17. I created this index based on the COTs data for the Dow Jones industrials, S&P 500, NASDAQ 100 and Russell 2000. It’s been in bullish mode since last March, but has fallen steadily after it hit a high of 1.22 in late September. (A reading of “1” or higher means all four of the indexes have just given a bullish signal.) The slight recovery in the latest report could mean we’ve seen the worst of the market’s woes.

In fact, almost all of my equity trading setups for equities are now in bullish mode, with the solitary exception of the NASDAQ 100. That one flipped to bearish as of the Oct. 9 COTs report, due to extreme bullishness on the part of the “dumb money” large speculator crowd. These folks are the big investment firms and hedge funds, which the data shows tend to be also wrongly positioned at market turns. In mid-October, they suddenly hit a historically extreme net long position, which was a warning sign that the market had a high chance of turning sour, as it did.

Another bullish sign comes from the Treasuries COTs data. All my Treasuries setups are now bullish (meaning they’re calling for rates to fall). In fact, my setups for the 30-year and 10-year Treasuries just gave renewed bullish signals in Friday’s COTs report. I think that means Bernanke & Co. could soon be changing their tunes about the need for more Fed easing. Falling rates should, in turn, be positive for equities in some measure. Of course, lower rates expectations also suggest the bond market is concerned about economic weakness. And that, ultimately, may not be so bullish after all down the line.