All About Sentiment?

I track various measures of sentiment within the marketplace but one that I find of most interest is the ISE Sentiment Index (ISEE). From the ISE site

put/call value that only uses opening long customer transactions to calculate bullish/bearish market direction. Opening long transactions are thought to best represent market sentiment because investors often buy call and put options to express their actual market view of a particular stock. Market maker and firm trades, which are excluded, are not considered representative of true market sentiment due to their specialized nature. As such, the ISEE calculation method allows for a more accurate measure of true investor sentiment than traditional put/call ratios.

I smooth the index value with a 20 day EMA to avoid the spikes and pitfalls of the index that occur from time to time. From there I can get some information on whether the market is overly bullish or bearish. I then cross this information with my own models and attempt to see a turning point is coming in sentiment.

So what does the current measure of this index along with my own model tell us about sentiment? That it is very bearish. The 20 day EMA went out last night at 98.40, off a low of 89.5 in mid June. This essentially says that investors are buying a smaller amount of puts than calls for the market. Over the past 7 years that I have data for this index, whenever this index is below 100 (more puts than calls), the market bounces rather aggressively to the upside. At the moment, we are day 40 of this moving average remaining below 100. This is the second longest period of time where this average has sat below 100 with the period of early 2008 when Bear Stearns collapsed being the longest at 50 days. When the index resurfaced above 100 during that time, the S&P, in very choppy style, proceeded to rally about 100 points.

Thus with the measure rising a more sizable rally would not be unthinkable. However, since this is day 40, I wonder if we continue to have choppy negative action through the end of this month and an August September move upward? My other measure that I use to confirm this index usually leads the ISE index and at this juncture is not positive yet. Thus net net, the market rally is coming but it might be a month away...not days.

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