Sentiment indicators point to rally in the days ahead

Whilst looking for inspiration for this mornings blog this weekend after what was largely a drubbing in the markets last week, I came across the following sentiment indicator details which although relating to the US has obvious spill over to the UK.

1.The most recent American Association of Individual Investors (AAII) poll is showing the most bearish reading since the August 2011 bottom, suggesting those retail players that are actively engaged are not feeling good about the market’s prospects. My own sense is that a lot of margined players were cut/flushed out last week in the UK too.

2. Equity option buyers, who grew optimistic right ahead of the election, are downright pessimistic, as the five-day put/call volume ratio is trading around extreme lows. This is my favourite indicator and for 6 days now the indicator has been popping over the key 1 level (ie 1 Put purchased for every 1 Call, typically it is around 3 calls for every 2 Puts) – as relayed on Friday, this is a strong signal that a bottom of sorts is close.

3. Total short interest on SPX components remains just below the levels of this time last year, which means the short-covering play is still intact. The caveat here is the shorts are feeling a lot less pain now than a few weeks ago, so the urge to cover is not as great now.

With valuations in the UK returning to very cheap levels, particularly in the mining sector (a rally is afoot this morning in some of our favourite stocks) and stocks very oversold, any more positive noises on the Fiscal Cliff and we could rally back to the 5800 level in the next several days in our opinion.

FTSE 10 day hourly chart

KEY LEVELS TO WATCH

9th resistance 5933 September 14 high
8th resistance 5922 Previous high
7th resistance 5921 Resistance line
6th resistance 5783 Previous resistance line
5th resistance 5775 Previous support line
4th resistance 5766 55-90min moving average
3rd resistance 5728 200-day moving average
2nd resistance 5718 61.8% Fib retracement
1st resistance 5683 Yesterday’s high
1st support 5605 Yesterday’s low
2nd support 5498 61.8% Fib retracement
3rd support 5480 Support line
4th support 5478 Previous low
5th support 5455 Previous resistance line
6th support 5230 June 1 low
Swen Lorenz: