Last August, we wrote about the extremes in market sentiment for two stocks at extreme ends of the alphabet – AAPL and ZNGA. Back then, it seemed that apple was going to take over the world, and perhaps a few neighboring planets as well. And we all were thrilled by that possibility. Meanwhile, Zynga could have rescued some puppies from a burning building and the blogosphere would have found something negative in it. Zynga was losing money, losing talent, plagiarizing game ideas, and they were closely linked to Facebook. Bad. Bad. Bad. Bad.
A classic contrarian play would have been to buy ZNGA and short AAPL. At the time, the ratio of Apple’s share price to Zynga’s was 218 to 1. You would have needed 218 shares of ZNGA to buy just one share of AAPL.
The trouble with guaging sentiment is that things can continue going to even greater extremes before finally correcting. That is what happened here. For another two months, the ratio kept tilting more and more in AAPL’s direction, reaching a peak of 286 to 1 (the chart above is smoothed slightly with a 3-day EMA). It took until January of this year for the ratio to decisively sink below where it was when we initially wrote about it.
And now? The ratio sits at 115 to 1. Apple’s shares have just made a 52-week low and some people are questioning whether the company has lost its mojo. At the same time, some are getting excited about Zynga becoming a player in online gaming. Does this mean it is time to reverse and go long AAPL while shorting ZNGA? We would not go that far. Remember, a year ago the AAPL:ZNGA ratio was a mere 40 to 1.
Twice within the past week, and for entirely unrelated reasons, we happened to find items related to the usefulness of forecasting. First, we read an article from Advisor Perspectives written a year ago by Adam Butler and Mike Philbrick (Predicting Markets, or Marketing Predictions). This was a review of the somewhat well-known phenomenon of “gurus” gaining notoriety more for outlier predictions than for accuracy. Nobody calls City Hall just to report that the street lights are all working. And nobody gets invited on CNBC for making moderate, boring forecasts.
But the fun does not end there. It turns out that your favorite Wall Street analysts are really great at predicting what has already happened. The authors cited a series of charts which show that expert forecasts tend to mimic reality, but with a lag. The gem of a chart below was originally published in the book Behavioural Investing.
Then we stumbled upon some research by CXO Advisory, which does alot of research on the accuracy of predictions. CXO had done a detailed assessment of the Hulbert Stock Newsletter Sentiment Index (HSNSI). This index purportedly can be used as a contrary indicator: when the surveyed newsletter writers are most bearish it should be a good time to buy, and vice versa.
They concluded, with some caveats, that the correlation between newsletter sentiment and short-term stock market returns was weak at best. Moreover, they observed that “HSNSI is, in fact, more strongly related to past than future stock returns”. So investment newsletter opinions are often more about what already happened than what will happen next. It is also quite possible, as the study noted, that any predictive power in Hulbert’s index could be confused with a simple reversion to the mean.
[ Note: This is the second time in little more than a month that we have written negatively about Mark Hulbert. We have nothing against the man. Never met him personally. It really is just a coincidence.]
Apple made headlines earlier this week for becoming America’s “most valuable” company. Ever. And now today we read this Bloomberg article which, quite hilariously, tells us that AAPL is undervalued because the stock’s P/E ratio is below that of the NASDAQ as a whole. Yes, everybody loves Apple. And guess what? It is underpriced. Buy more!
Ah, but the chart suggests otherwise. Yesterday market action completed a “dark cloud cover” pattern for AAPL shares. It is as ominous as it sounds, especially when coupled with the unusually high volume of shares traded yesterday. The latest rally is finished.
Meanwhile, at the other end of the alphabet we have Zynga. Everybody hates ZNGA. It seems whenever we hear the company’s name come up it is never, ever in a positive way. Maybe it is due to their connection to Facebook. Maybe there are good reasons to hate Zynga. But one thing is clear: everybody hates ZNGA.
Glancing quickly at ZNGA’s chart, it is easy to see why shareholders would be in a bad mood. However, we noticed that during the past month the share price has stopped going down. That things have stopped getting worse is hardly a bullish endorsement. But perhaps it is an early indication that a turnaround is in store for this unloved stock.
For the first time this year, the various indexes of the U.S. stock market are getting a pummeling. This is nothing new for the Russell 2000 (RUT), which stopped participating in the 2012 rally two months ago. We noted back in March that RUT was showing some potential signs of long-term weakness compared to its larger sibling, the Russell 1000.
Yesterday, the 2000 was extraordinarily weak in a weak market generally. RUT finished the day just slightly below its low set in early March. On the chart below, generated by masterdata.com, we find that the advance-decline line for the Russell 2000 is actually at its lowest point since the start of the rally in December 2011. Aside from the occasional “snap back” moves, we expect RUT will continue to underperform the broader market in the intermediate term (i.e. a few months).
Last week we noted that our index of advances and declines on the NASDAQ had reached a point which is often followed by a downturn in the market. Specifically, short-term tops are frequently seen when the index gets to +300 or so. Too much of a good thing has a way of killing the market.
Well our index now stands at a whopping 442 - a multi-year high! If we thought that the market was getting a little frothy a week ago – and we did – then we certainly advise taking a more defensive position at this time. As we write this, futures are looking down slightly. We think it is likely that the market falls more than just a handful of points, however.
Sadly, too much of a good thing almost always ends up being bad for us.
The stock market is no exception, as we will show on the following chart. It is generally considered a positive when a large number of stocks are participating in a rally. In other situations, where the market averages are going up but with relatively few individual stocks going up, it is a stern warning of things to come. So we like to see, in a healthy market, many stocks heading higher with the overall market. The problem is it is possible to have “too much”.
We calculate an index of advances and declines which is a cousin of the McClellan Oscillator. We prefer to apply it to the NASDAQ because that market tends to more clearly display the “animal spirits” that we want to measure. A number below minus 400 usually occurs at short-term bottoms. On the other hand, when the indicator reaches above 300 or so it often coincides with a short-term top. There is nothing magic about those specific numbers. It just happens to be what works.
The indicator broke above 300 on Wednesday and now sits at 307. It means there has been alot of “advancing” lately and in fact one more solidly positive day on Monday will push our index well above 300. As you see on the chart, the other two breaches of 300 in the past year were soon followed by sharp downturns. It doesn’t have to happen this time. There are cases in the past where the market started to head lower, then turned around and went to new highs. Still, we expect the market to be weak over the next week or so, with something more substantial looming.