Tom Drake's 2CS Senticator

One of the most underutilized methods of looking at the markets is probably sentiment....how fearful or greedy investors are feeling at any particular time. Here's a snapshot of Tom Drake's 2cents senticator. Tom's a regular poster on WollieWorld Forum at Crystal Ball http://www.crystalball-forum.com/context/main/wollieworld/ posting as "deuxsous", and at Don Wolanchuk's Valence thread on Silicon Investors http://siliconinvestor.advfn.com/subject.aspx?subjectid=52296 posting in cognito as "dospesos". He has permitted me to post his work here. For those who dont know him, Tom is THE sentiment meister having spent many years studying sentiment....one who is recently retired and most interested in capital preservation......so he necessarily needs to get a market pulse at all times to sidestep deep downdrafts.

Here's what he does. He uses the daily vix and cboe put call ratios and takes the summation of the product of these two numbers for the last five days. I believe he feels this compensates for any games that might be played by the boys.

The chart above plots the senticator against the Dow since early 2003, which is as far back as my data goes. Blue line is the Dow (scale on the right hand side) and the yellow line (scale on the left) is Tom's senticator. You'll see the senticator moves somewhat in tandem with the Dow, but that is not the important piece of this work. For ease of discussion, I've added a logarithmic trend line (least squares fit) of the senticator (light blue line) which from 2003 to present shows a gently down sloping line from about 60 to 80. Now, please note that since the senticator is the 5 day sum of vix times p/c ratio, as stocks rise and the vix and p/c fall, the senticator falls. Since I have a little dyslexia, I've actually turned his 2cs upside down.

Okay, what do we see? Note the 2cs coming out of the 2003 hole....similar in many respects to what we have happening right now. As the Dow climbed, likewise the 2cs climbed with it. Until it hit the log trend line (light blue line) more or less and then hovered above and below this trend line through all of 2004, 2005, 2006 and early 2007 (bull market territory). Once things started to go in the crapper in late 2007 and into 2008, the 2cs likewise dropped well below the log trend line and stayed below it.....even today we are below the trend line with a 2cs value of a little north of 100.

My interpretation: The 2cs, in a bull market, seems to have an affinity for hovering 0 to 20 points above the log trend line. What that means to me, in this environment, is that the rally will continue until the 2cs spends several months or even years bouncing back and forth from 60 to 80 (just above the log trend line), or......between 40 and 60 if past history in 2004 to 2007 is to be believed. A long, long way yet to go.

Notice how the 2cs "peaked" on July 21, 2009 (my wife's birthday) as has actually backed away from the peak all the way through the August and September run up. Meaning that as this rally has gained legs, sentiment has actually gotten more and more bearish! Under a similar situation in late 2003, the Dow simply ran up right through these "seasonally bad months" ahead of us and didn't peak prior to a significant correction until February 2004. So, hold on folks. Are there differences between then and now? Surely there are and there will be corrections along the way, but this senticator is saying, at least to me, higher prices are ahead of us, possibly much higher prices. Next weekend we'll take a look at a means of projecting these higher price levels.