Trader’s Narrative

There is a lot of material to cover in this week’s stock market sentiment summary, so let’s get started:

Sentiment Surveys
According to the weekly retail investor AAII survey, 29% of respondents are bullish - a tiny increase from last week. Meanwhile, 47% of respondents expect the market to decline going forward - an increase of 8% points.

More interestingly, the AAII asset allocation to equities continues to increase. The last time we looked at this in early May 2009, it had recovered from the abysmal level of 41% - the lowest on record. Now it is at 57% with most of the increase coming from a reduction in cash holdings which were at one point the highest on record at 45%.

While as a contrarian the ideal situation would be a continued pessimism (low asset allocation to equities), this isn’t really realistic. It is normal for people’s expectations to be recalibrated once the shock of a system wide meltdown recedes. And we also need for an orderly march towards optimism if the market is going to recover. That is the only way that new money will flow into equity markets and by increasing demand, drive up prices. We are far from extremes of 70% allocation that would provide cautionary signs. So it is a good sign that we are seeing growing optimism from this indicator.

ChartCraft’s weekly Investors Intelligence measure of newsletter editor’s sentiment is - oddly enough - split exactly down the middle: 35.6% bears and 35.6% bulls. Although this is rare, the more important thing is that this is a continuation of a short term trend in the increase of those pessimistic about future market prices and a decrease in those optimistic. Not long ago the bulls outnumbered the bears 2:1 but now, they are the same.

The Hulbert Stock Newsletter Sentiment Index, which tracks a small group of newsletters which try to time the market, is 15% points lower now than it was in early June. For those that time the Nasdaq, the mood is even gloomier: 27% points lower today than in June.

When you consider that almost all indexes are now trading slightly above last month’s highest levels, this gives new life to the spring rally. This is because while the recent decline spooked the average market timer enough to reign in their horns, the following sharp rally which made up for those losses did not made them rejoin the bullish camp. This reticence to become optimistic once again in the face of higher prices is bullish from a contrarian viewpoint.

While Wall Street strategists may get paid much more than the average retail investor, their prognostications have, on average, equal dependability - which is to say, not much. Just as the retail investors were fleeing from the bear market by reducing equity allocation and building cash and fixed income levels, the Wall Street strategists were also doing the same. In fact, their lowest level of equity allocation since 1997 coincided with the March 2009 low. And once again, in lockstep with their retail strategists, they’ve upped their equity allocation slightly in response to the higher stock market prices.
Continue reading ‘Sentiment Overview: Week Of July 17th, 2009′

Here’s this weeks’ sentiment overview:

Sentiment Surveys
According to ChartCraft’s Investors Intelligence survey, 40.4% of newsletter editors are bullish, while 31.5% are bearish. This ratio of bulls to bears takes us back to where we were in mid April 2009.

The US retail investor, as measured by the weekly AAII survey, has recovered quite well from the shell shocked state we found them in in early March 2009. In that sentiment overview, the AAII put in a new record bearish extreme with 70% expecting further declines in the stock market. Since then, they have recovered 37% points - that’s more than half.

So this week we are seeing a similar sentiment picture from the AAII survey: 44% bullish and 33% bearish. Check the link to see the only two other times in the history of this metric that we had seen such an extremely gloomy outlook from retail investors.

And finally, the AAII equity allocation jumped from 41% to 50% of portfolios. Most of this increase is coming from a reduction in cash holdings. While this may seem negative, it is required. Unless investors allocate more capital to equities, how can it appreciate? At the same time, the current allocation is still historically low; equal to late 2002 and early 2003, as well as early 1991 - all great times to jump back into the market.

Options Sentiment
The short term moving average of the CBOE put call ratio is about as low as in May 2008 - which was just before the market rolled over again and cascaded down into the November 2008 lows.

The ISE Sentiment is also showing similar levels of complacency. Today’s ratio was 191 - meaning that calls were purchases almost twice as much as puts. (not show on the chart below). That’s a little bit lower than the 225 call to put ratio from this Tuesday:

The previous high in this ratio occurred on December 30th 2008 (234) when the Santa Claus rally hit the wall. But notice that the high call buying cluster in mid April didn’t seem to faze the market in the least. The options market remains the one sentiment measure that has been strangely affected during this bear market. Maybe I’m not reading it correctly or maybe something structural has shifted. Either way, I’m growing wary of giving too much weight to it.

Volatility
After falling to a 6 month low in mid April, the CBOE Volatility Index (VIX) continues to drip lower. It is now below both its long term (200 day) and medium term (50 day) moving averages. As I pointed out before, while the VIX has been acting lethargic in comparison to the sprightly S&P 500, it seems to be begrudgingly confirming the rally.

While the VIX is saying that the market volatility is lower now than before, it doesn’t really feel that way to those that watch the tape every day. That’s because the market is just as volatile. As Mark Hulbert points out, if we count the number of days in which the market has risen or fallen 1% or more, it becomes apparent that we’ve seen as many of these ‘volatile’ days now as before when the VIX was almost three times as high.

Insider Activity
As mentioned before in a previous sentiment overview from a few weeks back, corporate insiders have started selling their company’s shares at a rapid pace. It is hard to believe but they’ve picked up the pace since then and pushed the ratio of sales to buys to a fresh highs.

Fund Flows
There is a change in the air. Investors are venturing out of their bunkers and taking on some risk. Equity mutual fund flows is now at a rate to be $8 billion for the month of May. While this may appear to be bad news, from a contrarian point of view, we have to keep in mind that any sustainable rally in the market requires fresh funds to fuel it.

As well US junk bond funds saw an $822 million inflow this week. So not only are investors taking on the kind of risk that comes with equity ownership, they are suddenly showing a very healthy appetite for the much more riskier asset class of junk bonds.

The Grey Beards
Once in a while I like to check in with the Grey Beards, the investment professionals that have seen more market action than most of us. Right now, they are for the most part bullish. Doug Kass of Seabreeze Partners, Jeremy Grantham of GMO and Richard Russell of Dow Theory Letters. Each of them has acknowledged that we are transitioning out of a bear market into a bull market. Some of them, like Russell, very grudgingly. By the way, I recently added Grantham’s latest client letter to the Free Trading Resource section (under Reports & Articles).

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Here are this week’s sentiment cross currents:

Investors Intelligence
The measure of stock market newsletter editors sentiment published by ChartCraft shows 36.0% as bullish and as 37.2% bearish. This is a reversal of the previous two weeks where we had seen the bulls outnumber the bears. It is difficult to dismiss the rapid increase in bullishness we’ve seen since the March lows as a hallmark of bear market rallies since we’ve seen the same II pattern in previous new bull markets.

American Association of Individual Investors
The sentiment survey of retail investors shows a reduction in number that were unsure from 29% to 20%. The 9% increase in conviction was almost equally apportioned, with 36% bullish and 44% bearish.

Perhaps more meaningful is the asset allocation of the AAII. They have a paltry 41% of their portfolios dedicated to equities. This is the lowest in the history of the survey (going back to 1988). It is slightly lower than what we saw on previous long term market bottoms: early 1991 and late 2002. As well, to highlight the insecurity the average American retail investor is feeling, they have pushed their cash allocation all the way to 45%. Not only is this an all time high it is the first time that the size of cash in portfolios has trumped equities.

Hulbert Newsletter Sentiment
Since the March lows, the HSNSI has jumped by more than 45% points. While some increase in optimism is warranted in a new bull market, this much of an increase is atypical of the historical playbook. During the first 52 days of the average bull market since 1965, the stock newsletter editors that time the market have on average only increased their bullishness 29.3% points. You can read more about Mark Hulbert’s recent research into the pattern of sentiment in new bull markets. This was featured a few days ago at news.tradersnarrative.com where you can find a continuous stream of interesting articles.

Option Sentiment
Nothing really new in this area, see previous week’s sentiment overview for further details. That discussion is still valid.

Sell In May And Go Away
You know the old Wall St. adage, “Sell in May and go away”. Well, here we are. We have now officially entered the time period which has historically been most difficult for the stock market.

So far we’ve had a tremendous rally off the March lows: the S&P 500 index gained 28.4% and for the two months of March and April, it has risen 25% with most of it coming from March. April’s gain was 8.2%

Looking at market cycles, this is rare. To see such a similar strong performance for the months of March and April we would have to go back to the 1930’s where intense bear market rallies were the norm. In those times, it wasn’t a good time to put fresh money to work (hence the label of bear market rallies and the annual cyclical nature of returns).

Big Money Poll
Last weekend brought out Barron’s quarterly Big Money poll. The small group of strategists surveyed were decidedly optimistic with 59% stating they were either bullish or very bullish. While a surprising 58% stated that they didn’t believe the market had bottomed yet, almost the same percentage (59%) identified the stock market as the best asset class for the next 6 to 12 months going forward. I’ll leave you to ponder the riddle of their logic.

The problem with the Big Money poll is that in its history, as a group, it has never been truly bearish. So while we would like to use it as a contrarian measure, we really can’t because for the most part it has no edge.

Drilling down into the sectors, the most unloved were Transportation and Utilities. In contrast, the Big Money poll liked corporate bonds, emerging markets (Latin America & Asia) and oil. But the one thing they almost all agreed on (84%) was to be bearish on US treasuries. This is puzzling since they’ve been persistently bearish on bonds for the past 8 years in the face of a powerful bull market in that asset class - especially in 2008.

Wall St. Strategists
The insistent bearish stance of the Big Money poll participants is in contrast to the current recommended allocation by the average Wall St. strategist. Right now they’ve peaked at a suggestion of 38.9% of client portfolios to (US long term) bonds, which is the highest in 12+ years. The last time they were even close to this level was in 1998 (34% allocation) when bonds topped and didn’t regain their previous high for another 3 years.

The asset class garnering the highest allocation is equities with a 52% weighing. Similar to the Big Money poll, Wall St. strategists are never outright bearish. Their bullishness is either raging or reluctant. So put in that proper context, the current allocation is very timid. It is the lowest allocation to equities since 1997. And during the bear market bottom of 2002-2003, their equity allocation was 68%.

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Here’s this past week’s sentiment wrap-up:

Investors Intelligence
ChartCraft’s famous sentiment indicator, measuring newsletter editor’s mood shows 31% optimistic and 38% pessimistic. So the slow, rebuilding of confidence continues with a gradual growth of the bullish camp. However, we did see, what has to be considered real bearishness. For example, consider that back during the end of the previous bear market (2002-2003) the II bullishness ranged from 40%-30%. And during this bear market we’ve see it in the 20’s for a few weeks. The question is, how comparable is this market to “normal” bear markets we’ve seen before?

AAII Sentiment
This week’s survey of retail investors shows a slight reduction in bears to 37% and an almost proportionally equal increase in bulls to 43%. This is natural considering the market moves we’ve seen but we are now once again in “no man’s land”, having quickly resolved the extreme pessimistic sentiment reading in February 2009. Contrarians are interested in not only extremes of sentiment but also divergences and while we saw the first, the second is missing so far.

AAII Asset Allocation
Although not as famous as the weekly sentiment survey mentioned above, the AAII folks keep track of another sentiment metric: how their members allocate assets between cash, bonds and equity. As you can imagine, moments of extreme are contrarian signals. For example, in early 2000, AAII respondents had on average a paltry 12% allocated to cash with the bulk of their portfolio (77%) in equities. We know how that story ended.

The last time we went over this metric was in a mid-February sentiment overview when the AAII asset allocation had skewed heavily towards bonds, reaching a decade plus high. Since then bond allocation has been reduced from 24% to 14% (I guess they beat a quick retreat when the bond market didn’t cooperate).

But more interestingly, the cash allocation is now 45% - an all time high!

And equity allocation is down to only 41% - an all time low!

As if we needed any further confirmation that what we are living through these days is a market of epic proportions. But there it is. The AAII equity allocation is now lower than at any time since the data - going back to 1988 - started to be collected.

Consumer Confidence
After reaching historic lows (again) in February, the Conference Board’s Consumer Confidence index inched higher in March (going from 25.3 to 26). For the most part you could argue that not much has changed from the perspective of US consumers. Most of the tiny uptick can be attributed to the Expectations index which measures consumer sentiment towards the future - it was up 1.6%:

We are still seeing generational lows in consumer confidence. This index was started in 1967 but the lowest handle it had ever had was 40 - until late last year when we made history (and continue to do so). The previous historic low was in 1974 during the dark days of that bear market and the next lowest was in early 1992. So it won’t surprise you that, within a long term view of the market, depressed consumer sentiment is one of many conditions necessary for a new bull market.