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Consumer sentiment lower, but market eats it up

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This morning's University of Michigan consumer sentiment came in at 86.5 for July, which was well below June's reading of 92.4 and lower than consensus estimates of 92.9. However, if anyone thinks today's lower sentiment numbers weren't factored into things and they were looking for any type of upside surprise, I think they are sadly mistaken.

It has been noted by many economists and here at OptionInvestor.com that consumer sentiment is greatly influenced by stock market performance. The recent beating the markets have taken in the recent month and investors fleeing to Treasuries wasn't initiated by any type of "gain" in confidence.

As such, we did see stocks dip to their lows of the session, but are now back at session highs as the more heavily shorted stocks in recent months in the NASDAQ-100 Index (NDX.X) 1,022.29 +2.43% pegs a session high. Action here definitely looks like bears bought the weakness of the sentiment numbers that they had factored into things and used that weakness to further square some positions and lock in gains from the past month.

While this is encouraging for equity bulls to see bears getting aggressive with their covering at the lower risk levels as depicted by the NASDAQ-100 Bullish % ($BPNDX) the real key for any thought of a bottom being put in most likely will be told from the Treasury bond market, where cash has been horded in the past several months.

I've gotten a lot of e-mail this morning regarding the bullish % charts and there's confusion on how these bullish percent charts hint that bears are carrying the bulk of risk.

One way to try and understand the bullish percent is to think of it almost as you would the Market Volatility Index (VIX.X).

Market Volatility Index Chart - Weekly Interval

Option traders seem to have a better grasp of the Market Volatility Index (VIX.X) and will use it as a contrarian indicator. However, it can be tough for traders to actually "time" market turns or really understand at what point a "signal" is given from the VIX to indicate a true turn from a high or low is taking place.

The above chart is a broader view of the VIX.X on a weekly interval. If set the upper end of retracement at historical high levels of VIX trading, with 0% at the upper end. Make the tie here perhaps to the bullish %, which can achieve a potential level of 0% at an extreme LOW. Then I've set the lower 100% of retracement to also get a mindset for an extreme level of bullishness with the bullish % chart at its extreme HIGH level of 100%.

So why does the market bid after a poor consumer sentiment number? One explanation is that RISK runs HIGH for bears and they're more willing to buy the weakness, to lock in gains, and REDUCE the risk in their accounts. Option traders will also use the higher option premiums to lock in gains on puts, and some bulls will actually use inflated put premiums to sell naked puts on stocks they're willing to buy should they get exercised, but the inflated premiums allow for a potential "below market" price entry point, giving them some near-term cushion to let the stock find a base. If the stock they've sold the naked put on rebounds higher, then the naked put trader simply keeps the "jacked up premium" they sold to begin with. If the stock does close below the put strike price they sold, then they may still take the position of the underlying stock once assigned, but if they've done their homework and the stock remains technically sound, will hold the underlying stock and look for the rebound they were anticipating to benefit from the stock's and market's recovery at a lower risk level as depicted by the bullish % and the more contrarian Market Volatility Index (VIX.X).

Jeff Bailey
Senior Market Technician
Option Investor

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