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Is the Market Oversold? UPDATE

Posted by Larry Doyle on March 12, 2009 2:28 PM |

A few weeks ago, I wrote a piece on whether the market was oversold. Allow me to re-introduce a few topics . . . 

The market valuation of any asset is determined by three factors:

1. Fundamentals: measures items such as cash flow analysis, cost-benefit analysis, earnings before interest, taxes and depreciation (EBITDA) 

2. Technicals: measured by regression of price movements to determine overbought and oversold conditions

3. Psychology: measured by unscientific surveys of market participants

I have never seen such divergent views on expected future earnings which directly impacts any reasonable fundamental analysis.

And now the update:

Differing technical analysis has the market in the early stages of being oversold but not dangerously so. 

Psychology is becoming decidedly bearish.

Add it all up and we have markets that are clearly bearish and perhaps not surprisingly we have seen a rally and may very well see a further rally back toward the 7100 level on the DJIA. That 7100 level represents a Fibonacci Retracement  level I wrote of on March 6th.  Much as we traded around the 8800 level (another Fibonnaci number), I would now not be surprised if the 7100 becomes the center of another short term trading range. Markets can correct oversold conditions by marking time with sideways price action (effectively running in place).   

On the psychology front, I think it is beneficial to review an unscientific survey managed by one of our Economic All-Stars (see left sidebar) Laszlo Birinyi. This survey, the Blogger Sentiment Poll, comes out weekly and measures respondents’ bullish, bearish, and neutral outlooks. For comparison purposes, I have compiled a chart of Birinyi’s survey from the last several weeks. The bullish measures have moved  lower, bearish sentiments have moved sharply higher, and neutral sentiments are decidedly lower. 


This unscientific survey is targeted at active market participants. Based on my experience, a lot of these surveys run together. Back on February 25th I said “unless and until I see measures of bullishness approach the 25-30% area will I believe the market is oversold.” Well, as we can see with the moves of the last two weeks, the market is approaching that oversold range. 

Further evidence of an oversold condition is provided in a Bloomberg story, Stock Market Bears Grow More Convinced 17 Month Rout to Deepen. A major bullish barometer in this piece registers in at a paltry 29%!!

Again, these polls do not mean the market is going to race higher. Markets can correct overbought or oversold conditions via a corrective price action or by marking time. Thus, as I indicated previously, we may do slightly better and/or run in place for a while prior to making another new low. What may be the catalyst for a new low? A sovereign default emanating in Europe.  A municipal default here in the United States. More disconcerting fiscal programs coming from Washington. 

I’ll be watching. Any questions? Don’t hesitate to ask!!


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