Trader’s Narrative

Here is the sentiment summary for this shortened holiday week (Happy belated Canada day and 4th of July!):

Investors Intelligence
Stock newsletter editors were on average unchanged from last week: bulls 41.4% and bears 29.9%.

AAII
The weekly retail investor sentiment survey from AAII shows a sudden jump in optimism: the bulls came in at 38% - a 10% point jump from last week. While the bears are 45% of respondents, a drop of 4% points from last week.

It is difficult to parse the meaning of this move back and forth. First much more bearish, now decidedly less so. Since we didn’t really reach any levels of historical significance with this sentiment indicator, the only thing we can safely say is that retail investors are skittish but not despondent.

Barron’s Confidence Index
This is among Richard Russell’s favorite indicators. The Barron’s Confidence Index is a ratio between Barron’s high-grade corporate bond index and Barron’s intermediate-grade corporate bond index. So basically it shows how much or how little demand there is in the more speculative, lower grade bond market.

The lower the Confidence Index, the less inclined people are to accept risk in the bond market and the higher, the more they are willing to take on risk. Historically 60 has been considered an extremely low level. But as you can see, we easily sliced through that level during last year’s credit market turmoil:

Source: Plexus Asset Management

But since the low late last year, the credit market has improved and we are now trying to return to normalcy. There is a high correlation between this indicator and the equity markets, which is why Russell follows it so keenly. It can be considered a good proxy not only for the bond sentiment but for the over all appetite for risk. There are many indications which confirm this point of view, for example the return to earth of the TED spread.

You can follow the indicator by rifling through the pages of Barron’s print edition or you can alternatively find it online.

Magazine Cover Indicator
This week’s magazine cover sentiment comes courtesy of Business Week, purveyor of many fine contrarian cover indicators in the past. This week’s cover asks:

Can You Afford to Retire?
After watching their savings evaporate and their net worth plunge, many are giving up on retirement planning.

The graphics is a clever play on the falling stock market, in a thick red line… which transforms into a beach lounge chair.

On the whole it isn’t ’slash your wrists’ or ‘Death of Equities’ gloomy but you have to wonder if this kind of cover would have even been contemplated in 2007.

Here’s this week’s sentiment overview chock full of sentimental goodness. Enjoy:

AAII
This week’s AAII sentiment survey moved the bulls and bears in different directions, albeit both by the same 2 percentage points. The bulls move up slightly to 24% and the bears fell slightly to 55%. Looking at the ratio of bulls and bears, we’re back to levels that we last saw in mid-July 2008 - not that it did the market much good back then. While it shows some real concern by the retail investor, it still doesn’t show extreme levels of fear. As well, the slight amelioration doesn’t bode well because when the survey was taken, the market was still at support.

Investors Intelligence
The newsletter editors, as measured by ChartCraft’s weekly sentiment indicator are 28.6% bullish and 45.1% bearish. That’s a move in the right direction but not enough to give any contrarian a reason for pause. The last time we saw real fear was late last year when there were the bullish camp was as small as ~20% and the bears more than half.

Conference Board Consumer Confidence
The Conference Board Consumer Confidence Index was released this week and it wasn’t pretty. We hit another low when it fell again to 25.0 - in fact, all three measures (including present situation and expectations) fell again. Consumers that described business conditions are “bad” rose to 51.1%. There was also a jump in people’s expectations of job losses - 47.3% from 36.9%.

Barron’s Confidence Index
Richard Russell introduced me to this lesser known indicator. It is a ratio of the high grade bond index and the intermediate bond index. Since it measures stress in the bond market, you won’t be surprised to learn that during this latest bear market it has fallen to an unprecedented degree. In November 2008 it fell to 45 and the latest weekly data is 51.6. To put that in perspective, during the end of the last bear market the Barron’s Confidence Index made a sloppy double bottom in the 65-70 range. A You can keep track of it online at Barron’s website or by leafing through the Market Lab section of the printed edition.

ISEE Sentiment
The call-put ratio known as the ISEE sentiment index actually went up on Friday, as the S&P 500 broke down to levels not seen since December 1996. I prefer to look at the equity only data for the ISE because it strips out the index and ETF trades. While not extremely high, the fact that it increased to 157 is a conundrum. It means that on average, the retail options trader on the ISE opened 157 calls for every 100 puts.

At first I thought that perhaps the fact that breadth has been favorable would account for this. While the large cap stocks fall, dragging the indices with them, more and more mid to small cap stocks are not making new lows. So perhaps the options data would suggest that option traders are betting on non-large cap stocks. But on the other hand, stocks have to meet certain criteria to have options and for the most part, those are larger capitalization stocks.

OEX Option Sentiment
The S&P 100 index put call option ratio is once again at a bullish extreme. Two weeks ago I mentioned that the OEX options sentiment was sliding to levels which have previously been interpreted as very bullish. This week, they continued to fall, registering the lowest daily ratio in about 25 years. While normally this would be wildly bullish, there are two problems with this.

One, the number of contracts traded in this specialized options market has been steadily eroding and it has reached a very small number. So small that it is questionable if the data holds any real value. Second, recent extremes haven’t really yielded any actionable consequences for the market. While more and more bulls pile in buying OEX calls relative to puts, the market continues to slide.

Nova Ursa Rydex Ratio
The Rydex family of funds were the first precursors to the ETF smorgasbord that we have today. Although pushed further to the periphery with each leveraged ETF, they are still around and command a significant chunk of funds under management. The Nova Ursa ratio measures how bullish or bearish the Rydex investors are feeling at any moment. The Rydex Nova returns 150% of the S&P 500 daily returns while the Ursa fund (now known as Inverse) attempts to return the opposite returns generated by the S&P 500 index.

The current level of bullishness - as measured by how much money is dedicated to Nova vs. total funds in Nova and Ursa - is at a decade low. To find a lower ratio, you’d have to go back to late 1995. The next lowest level after that was late last year (November 2008) and previous to that early 2003. This has been a wonderful signal in the past. Two things could dampen its power: one, similar to the OEX options sentiment, the level of participation in Rydex funds has waned as people move to ETFs and leveraged ETFs. Second, back in the early 1990’s we saw the extreme readings pile up in stacks, week after week, throughout 1994, until the S&P 500 index took off like a rocket in early 1995.