Trader’s Narrative

The following article was adapted from the November 2009 Elliott Wave Financial Forecast and reprinted with permission here. Until Nov. 11, you can read the rest of this brand-new report for free, during Elliott Wave International’s FreeWeek of U.S. forecasts. Learn more about FreeWeek, and download the rest of this report and others for free here.

By Steve Hochberg and Pete Kendall

When Wall Street’s total value of assets rose to a “mind-boggling 36.6 percent of GDP” in late 2006, The Elliott Wave Financial Forecast published a chart of U.S. financial assets literally rising off the page.

The Financial Forecast observed that financial engineers had “found a new object of investor affections—themselves” and asserted that “the financial industry’s position so close to the center of the mania can mean only one thing; it is only a matter of time” before a massive reversal grabbed hold. Financial indexes hit their all-time peak within a matter of weeks, in February. The major stock indexes joined the topping process in October 2007 and in December 2007 the economy followed. Subscribers will recall that one of the most important clues to the unfolding disaster was the level of financial exuberance relative to the fundamental economic performance.

This chart of the value of U.S. trading volume (courtesy of Alan Newman at www.cross-currents.net) reveals that the imbalance is far from corrected.

Incredibly, total dollar trading volume is even higher now than it was in 2007 when the economy was humming along. In June 2008, dollar trading volume also defied an initial thrust lower in stocks and the economy, eliciting this comment from the Financial Forecast:

The chart of dollar trading relative to GDP shows how much more willing investors are to trade shares in companies that operate in an economic environment that is anemic compared to that of the mid-1960s. A basic implication of the Wave Principle is that the public will always show up at the end of a rally, just in time to get clobbered. This chart shows that it is happening in a big, big way now because the market is at the precipice of the biggest decline in a long, long time.

Total dollar volume continues to rise despite further fundamental financial deterioration. Yes, GDP experienced a one-quarter, clunker-aided uptick of 3.5 percent in the third quarter. But the economy is in far worse shape than it was when we made the above statement. In fact, its recent performance on top of the decades-long economic underperformance (which is discussed extensively in Chapter 1 and Appendix E of the new edition of Robert Prechter’s Conquer the Crash) means that industrial production just experienced its worst decade since 1930-1939. Total manufacturing employment slipped to 11.7 million people, its lowest level since May 1941 when it was 33 percent of all jobs. According to Bianco Research, manufacturing now accounts for only about 9 percent of the workforce. Finance anchors the economy now, which makes it far more susceptible to non-rational dynamics.

As Prechter and Parker explain in “The Financial/Economic Dichotomy” (May 2007, Journal of Behavioral Finance), a financial system is not bound by the laws of supply and demand in the same way that an industrial economy is. In finance, confidence and fear rule decisions. “In the financial context,” say Prechter and Parker, “knowing what you think is not enough; you have to try to guess what everyone else will think.”

We do know one thing: When everyone is thinking the same, the opposite will happen.

Right now, record high dollar volume of trading shows that confidence, at least on this basis, has reached a new historic extreme.

Read the rest of the 10-page November 2009 Elliott Wave Financial Forecast now, when you signup for Elliott Wave International’s FreeWeek of U.S. forecasts. FreeWeek ends Nov. 11, so please act now to get an enormous wealth of current market analysis and forecasts — for free. Learn more about FreeWeek, and download the rest of this report and others for free here.

For economic and market news and to see what interesting reading you may have missed last week, check out the list below. To see it all, go to news.tradersnarrative.com:

• Bill Moyers interviews James K. Galbraith
• Market Is Strong, But Correction Should Continue
• Contrarian analysis remains bullish
• Goldman’s long term borrowing cost 0.92%
• Get a FREE Subscription to SFO Magazine (US residents only)
• EU to break up Lloyds, RBS and Northern Rock
• Schwab Creates Watershed Event with Commission-Free ETFs
• CNN Interviews Robert Shiller on Economic Recovery
• EWI FreeWeek almost over, hurry! Learn more about FreeWeek, and download your free reports here
• Mother of all carry trades faces an inevitable bust
• Four Simple Ways to Fix the Broken System
• Clever fools: Why a high IQ doesn’t mean you’re smart

The above is a small sample, for the complete list, follow the graphic link below to news.tradersnarrative.com:

And remember to check back during the week as there are interesting links added throughout the week. If you are a twitter user, add the news.tradersnarrative.com twitter stream to get new stories in real time.

The Week Ahead:

This week the sentiment data brings a very intriguing turn of events so let’s get started:

Sentiment Surveys
The star this week is the ever so humble and common AAII weekly survey of US retail investors. This sentiment indicator sends extreme signals every once in a blue moon. So I guess you better check the night sky tonight because we haven’t seen so few bulls in this survey in a long time.

This week’s AAII results show only 22% bulls and a whopping 56% bears. The last time we saw this few optimists and this many pessimists was the week of February 19th 2009. Just before the spring rally. To put that in (even more) perspective, out of all the data that we have so far, only 4% of the time have there been less bulls.

Here is a chart of the bull ratio (bulls divided by the total number of bulls & bears):

I’ve zoomed in to the past 7 years or so since showing the whole time series from 1987 would be overkill. From 2002 till now, there have been 8 instances where the AAII bull ratio was less than 30%. But as the last extreme reading in February suggests, it is best to not act in haste when presented with such a scrumptious contrarian gift. Historical data suggests that sitting on your hands for the next few weeks is the most prudent strategy (for longs).

I hope that I haven’t understated the gravity of this week’s AAII sentiment survey result because there is a high probability that it will once again prove to be prescient in pinpointing an upcoming inflection point. It is most definitely a tell that after a 55% rally we find the AAII bull ratio at such an extreme low when in early 2004 after a 37% rally from the 2003 lows the bull ratio was at the other extreme (see above chart).

The one puzzling thing is that the AAII asset allocation survey shows a slight uptick in equities (to 57%) while back in February when the bull ratio was so low last, it was closer to 40%. I guess the message the AAII folks are sending is that they like equities longer term but short term they’re very nervous. And that’s remarkable because of how little off we are from the year’s highs.

Investors Intelligence
While this week the AAII deservedly monopolized our attention, the measure of newsletter sentiment from ChartCraft is a snoozefest. The II this week is almost completely unchanged with 48.3% bears and 24.7% bears for a (yet again) bear to bull ratio of 2:1. I’m not sure how to reconcile these two disparate metrics but I do know that this is really nothing new as they often conflict with one another.

Hulbert Newsletter Sentiment
Thankfully, we have another measure of newsletter sentiment. Currently, the Hulbert Stock Newsletter Sentiment Index (HSNSI) stands at 3.2% - which implies that the average recommended exposure by short term timing newsletters is to be long 3.2% of their client’s portfolio.
Continue reading ‘Sentiment Overview: Week Of November 6th, 2009′

This is a guest post by Wayne Whaley, CTA:

Before presenting my latest seasonality study - which may be the most statistically significant - here is a short summary of the previous three studies that I have shared with you. Enjoy.

End of Year Positive Bias
Since 1950, the average annual return on the S&P 500 index has been 8.05%. Over half of that (4.25%) annual return has on average occurred in the three months, November to January.

(Abnormally) Positive Septembers
September is usually the weakest month of the year. But when September has a positive return, the last 3 months of the year have a strong positive bias (21-4) and an average gain of 4.84%. For full details, see: When September Flexes Its Muscle

Positive Septembers - Negative Octobers
If the a positive September is followed by a negative October, then the odds for the last two months of the year go to 10-1 with an average gain of 4.71%.

Seasonality When Jan-Oct Returns Are +10%
If the first ten months of the year provide a 10% or more return, then the final two months of the year are 21-3, with an average gain of 4.99% (see table to the left for details). Perhaps more interestingly, there was not a one percent loss in the the 24 observations.

If the end of the year rally doesn’t materialize with the tail wind of the above statistics at its back, it should be viewed as very bearish for the first quarter of 2010.

Gold has the wind at its back right now. Not only has it cleared the challenging $1000 resistance level, it has support from lax monetary policy as central banks around the world clearly hold the health of their economy in higher priority than the health of their budgets or their currencies.

The recent purchase by the central bank of India is being interpreted widely as a vote of strong support for the precious metal. Although I don’t argue against a secular bull market, it is amusing to me that a decision to buy gold at above $1000 is deemed to be a ’smart’ move when just a year ago they could have made the same purchase for 30% less. The fact that almost any news is interpreted as positive for gold has more to do with the prevalent sentiment than with facts.

In any case, before we get to the short term sentiment for gold, here is the recent commentary from David Rosenberg of Gluskin Sheff on the monetary backdrop for a secular bull market in gold:

All India did was bring gold to a 6% share of its total FX reserves from 4%. Fifteen years ago, that representation was closer to 20%. China has increased its gold holdings by 76% over the past six years but they are a mere 1.9% of the aggregate 2.2 trillion of reserves and Russia’s gold holdings is just under 5%. This is not the 1990s when Bob Rubin was running a hard U.S. dollar policy, U.S. fiscal deficits were vanishing and gold production was on the rise. Today’s world is exactly the opposite. Policymakers beginning in the 1990s wanted disinflation and got it. Now they want inflation — it will take years, maybe a decade, but it will come. For the near-term, we are still optimistic on Treasury securities but be forewarned that this view has an expiry date that is earlier than the peak we are likely to see in gold.

It is very clear that central banks are behaving in a way that would suggest that gold is now again being considered a currency within the global monetary system. As we said before, it is all about relative scarcity and a well-defined supply curve — fiat currency at this juncture does not share that quality.

Turning to the breadth in the gold stock sector, you can see that we’ve seen a sudden and dramatic jump from a week ago. The chart below compares the percentage of gold stocks trading above their 10 day moving average with the Philadelphia Gold Bugs index (HUI):

If you’re interested in timing the gold market, then you would be concerned that 82% of gold stocks are trading above their short term moving average. But you would also be alarmed that just a few days ago, that number was below 10%. Historically, gold shares have a very tough time continuing to climb when faced with such short term headwinds.

Turning to sentiment in the gold sector, on Monday when we looked at the arguments that Paul Tudor Jones II presented for his case of a secular bull market in gold, we also digressed a little to check the Hulbert Gold Sentiment index. That sentiment measure was showing a majority in the bullish camp; which from a contrarian point of view means that gold probably will have difficulty in advancing in the short term.

In a similar vein, here is a chart, courtesy of Elliott Wave, which shows the price of gold with the Daily Sentiment Index (DSI). The most recent DSI is 91% which is just about where previous short term tops have been formed:

Similar to the breadth measure (shown earlier) the DSI increased to 91% in a sudden jump (an 8% point jump over a day). Accoding to Elliott Wave, which tracks the DSI, this was the single largest increase since March 19th 2009 (11% point jump from 75% to 86%) when gold made a two month high at $960. With Elliott Wave, not only do you get their analysis of various markets but they do a good job of monitoring DSI, which is a proprietary sentiment metric from trade-futures.com and by itself would costs about $2000/year.

Elliott Wave, by the way, is offering a rare limited time access into their premium content right now. FreeWeek happens only once or twice a year and provides you with full access to what subscribers normally pay more than $700 a year:

• Robert Prechter’s NEW October 2009 market letter, The Elliott Wave Theorist ($29 value)
• Steve Hochberg’s and Pete Kendall’s NEW November 2009 market letter, The Elliott Wave Financial Forecast ($29 value)
• Recently archived issues of the Theorist and the Financial Forecast ($29 value each)
• And a week of free access to Steve Hochberg’s Short Term Update, designed to keep your finger on the pulse of the following markets throughout the week: Dow, Nasdaq, S&P, Gold, Silver, Bonds ($39/month value)

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