Trader’s Narrative

The sentiment overview for this week in the markets:

Sentiment Surveys
The usual suspects: AAII, Investor’s Intelligence, LowRisk, Consensus and Market Vane did not vary significantly over this past week so I won’t go into detail.

ISE Sentiment Index
Although technically a measure of options activity (ratio of puts to calls), the ISE Sentiment Index (ISEE) reached a 32 trading day high yesterday at 151. Today’s reading hasn’t been release but going by the intraday data, my guesstimate is in the high 140 range (UPDATE: 154). The 10 day moving average of the ISE put/call ratio has reached 118, well off its multi-year low in the 90’s range - where it gave a wonderful signal to mark the inflection point.

Magazine Cover Stories
This unusual sentiment indicator only gives signals sporradically but when it does, it pays to take notice. In August there were multiple negative cover stories. Here are 3 that I caught:

Notice the liberal use of the color red (with its obvious and subconscious connotations). Also, the Economist cover art not only shows a surfer, perilously hanging ten - about to be engulfed by a larger wave behind him - but those grey specs are four sharks in the water waiting for the inevitable.

The last time I featured a negative Economist cover was last summer when they ran a photo of a bear in the woods, just as the stock market was in the middle of its correction. The swoon lasted another month and prices dipped slightly lower than when the cover story appeared but clearly the worst was already over.

And lest you think that cover stories only have contrarian power when they are bearish, consider the glowing Akamai cover story in Forbes magazine in mid-April when it was trading around $50 a share. Now it is scraping $30.

A little late due to travel, but as they say, better than never…. here’s the sentiment recap for the past week:

AAII
Still too many bulls in this sentiment reading (40%) but the bears are still outnumbering them at 46%. There’s no denying that during this correction the Mom’n'Pop retail investors have come across as outright cold-blooded creatures. My own personal theory is that they simply don’t care about the stock market because they have very little invested and therefore, little at stake.

Investor’s Intelligence
No real change in this indicator. The newsletter writers are pretty much where we last left them last week: about equally split between the bulls and bears.

I’m a bit puzzled why this sentiment indicator is so flaccid. Especially when you consider that according to Hulbert, newletters are rather spooked (see below). My hunch is that Chartcraft and Michael Burke (editor) have a slightly different interpretation of newletter writer’s intentions. You have to remember that unlike many of the other sentiment measures, this one involves a subjective call which categorizes the letter as bullish, bearish or neutral.

Hulbert Stock Newsletter Sentiment
The HSNSI closed August at +5.5%- this means that for the newsletters that try to time the market in the short term, they are on average only recommending being 5.5% long this market.

Although this measure has risen from about two weeks ago when it reached -11.3%, it still provides us bulls with some ammunition. That’s because in the face of a ~600 point rally in the Dow, the newsletter timers have only dipped their toes into the stock market.

Had they rushed in wholesale, things would be different. But they are obviously still timid and only reluctantly admiting that the market isn’t all that bad after all.

Consensus
Consensus bullish sentiment reacted sharply to the market’s gyrations by jumping 7% last week. It had plumbed depths that it had only seen before during last year’s August correction.

Market Vane
In contrast, Market Vane hasn’t really budged. At 53%, it is still quite low. And although I referred to an interesting interpretation of its recent behaviour during the last weekly sentiment review, I still think it should be interpreted from the traditional upside down, contrarian point of view. So nothing new here.

Massive Doomsday Options Trade
Finally, I wanted to touch on the story that has been making its way around the internet, trading discussion forums and even CNBC: that a massive options trade has been put on which predicts that the market will crash in the coming months.

The details of the story are pretty much everywhere. I found mentions even on digg and reddit. Ugly mentioned it a while back when it was just going viral. Make sure you also check out the discussion in the comments section.

When I heard it, I must confess, it made me chuckle.

Would anyone really put on a one sided options bet like that? and would they do it via the very public options market rather than the more private swap market?

If you believe this conspiracy theory, you need to get in touch with me stat. I’ve got a wonderful bridge in Estonia to sell you for a very reasonable price.

But seriously, this sort of doomsday story goes viral because it feeds on people’s fear (and ignorance). And that is a truly insightful contribution to sentiment.

Since over here we practice contrarian analysis when it comes to sentiment, this is exactly the sort of brick that walls of worry are built from.

Yowza! Looks like nothing can keep this maket down. Not yesterday’s profit taking, which was long overdue! And certainly not the news that terrorists are in the advanced planning stages of a hit on US interests in Germany. One way or another the market finds a way to keep going up. So let’s take an overall look at the sentiment picture out there:

AAII
After last week’s historic reading, the AAII survey this week has ameliorated and now shows a tie with both bulls and bears at 43%. The AAII sentiment survey is now neutral and the only sentiment metric out of the group which is not showing more bulls than bears.

Market Vane
Market Vane’s Bullish Consensus is calculated by going through brokerage, analyst and CTA recommendations on a daily basis. Currently it stands at 72% bullish. But since early 2004 this has had a bias towards bullishness. The lowest it has been in the past 3 years is mid-50%’s. Since this sentiment indicator can get stuck either bearish or bullish for a length of time, we have to look at it on a more relative basis.

Investor’s Intelligence
Currently the II is showing 20% bears and 53% bulls which gives a bull ratio at 0.72. This is rather high, by contrarian analysis bearish. Evenso, we’ve seen the market power ahead inspite of II readings at this level. For more information on Investor’s Intelligence.

Consensus
This sentiment survey is similar to Market Vane’s in that it is comprised of brokerages, advisory services, analysts and CTAs. And like Market Vane’s it can become mired on one side of the sentiment landscape. Right now it is at 74% bullish, which is approaching 3 year extremes. From a contrarian point of view, this is bearish for the market.

LowRisk
The LowRisk.com survey is done online each week with participants filling out where they believe the Dow Jones will finish: up 2%, down 2% or unchanged. Since this is the most jittery metric, it is useful to take a short term moving average to smooth out the data. Right now, it is sitting around the neutral zone with almost as many bulls as bears.

It is fine to look at how market participants claim they feel about the market, but we still have to look at what they are actually doing. To do that, lets take a look at Commitment of Traders and short interest data:

Commitment of Traders
This data is from the Commodity Futures Trading Commission (CFTC) and shows how small speculators, commercials and large speculators are positioned in the futures markets. Right now, the small speculator - usually the market participant to fade - is positioned short. This would be bullish from a contrarian point of view.

Public Short Interest
This data is released by the NYSE with a 2 week lag. When the public is heavily active in shorting stocks, it has usually been a very good contrarian indicator that we are bottoming. Right now though, we are seeing a derth of public short selling which has pushed this indicator to the extreme seen usually at market tops.