Trader’s Narrative

Here is this week’s sentiment summary:

Sentiment Surveys
Figures from ChartCraft’s Investors Intelligence show stock newsletter editors to be similarly bullish to last week: 43.6% bullish and 28.7% bearish. Not only is this little changed from last week, it leaves us mired in a neutral morass which is not really helpful in determining a trend.

In contrast, the weekly AAII data is a bit more attention grabbing. As measured by the American Association of Individual Investors, the percentage of US retail investors who are bearish increased by 3% points to 49% and those who are bullish declined by 5% points to just 28%.

As you might recall, we saw a record setting AAII bearishness that coincided with the start of the spring rally. This week’s sentiment figures are the most pessimistic since then. While some would interpret this as bullish for the market, it may not be that simple.

While sentiment is helpful in pointing out inflection points at extremes, the rest of the time as it meanders it is either not really helpful at all. If you really want to analyze it, sentiment tends to go along with the trend in the market until it tips into a severely lopsided situation. So in fact, while we are not seeing extremes, sentiment can be seen as a guide to confirm a trend, rather than as a contrarian indicator. This is a distinction that makes sentiment much harder to analyze than merely zigging when it zags.

Therefore, since the AAII data isn’t at an extreme level of bearishness, we can’t really use it as a contrarian measure. All we can say is that fewer people are bullish, which means that less and less are feeling like putting money to work. That isn’t necessarily great news if you’re bullish.

Finally, the Hulbert Stock Newsletter Sentiment Index which is another measure of stock newsletter editor’s stance has fallen from 45.8% early in June 2009 to just 15.8% in recent days. Such a retreat confirms what we are seeing in the other sentiment data (above); bullishness is fading to varying degrees but it is not yet at a point of extreme. Mark Hulbert, the creator and keeper of this sentiment indicator, believes that such a move has contrarian portent because while sentiment has fallen to levels last seen in early April, the market is much higher.

Options Sentiment
The CBOE put call ratio’s short term moving average is climbing higher after reaching a low in mid May 2009:

Keep in mind that the put call ratio has a slight upward bias so if you draw a line you can see the connection between the July and October 2007 put call ratio lows - which coincide with the bear market top. While this measure of sentiment has increased in recent weeks, it is a long ways off reaching previous highs of 0.85+.

Below is an updated chart of the ISEE Sentiment Index (equity only) which I showed about a month ago:

Similar to the CBOE put call ratio, we’ve seen a decrease in bullishness (notice that the ISE is inverted because it is a call put ratio). Since early June 2009, the 10 day moving average has come almost straight down from 181 to 152. But as you can see, it is far from an extreme low. On November 24th, 2008 the 10 day moving average of the equity only ISE call put ratio was 108 and on March 24th, 2008 it was 104.

I’d caution you to take all options analysis with a salt lick. Both the CBOE and ISE data has not conformed to historical ‘norms’ of sentiment analysis during this bear market. For example, notice that neither recognized the March 2009 lows.

Volatility
The CBOE volatility index (VIX) continued its slow, meandering crawl downwards this week. It closed a hair’s breadth below 26, which is the lowest it has been since September 15th 2008. The VIX has fallen off many radars because during this bear market it reached unheard of levels and as a result, what was once considered extreme is now the new ‘normal’. I suspect that it will be a long time until we can put this whole episode behind us and take a look at the VIX the way we used to before.

Here is the sentiment overview for this Easter shortened trading week:

AAII Sentiment
This week’s sentiment survey from the American Association of Individual Investors shows 44% bears and 36% bulls. That’s a 7 percentage point change from last week for both camps (a decrease for bulls and an increase for bears).

This is a welcome development because although the market (S&P 500) closed the week higher than it started, sentiment is actually less hopeful than it was. This is just one glimmer of contrarian sentiment and it is a shallow change (at only 7%) but still it is valid. At this point, we’ll take what we can.

Investors Intelligence
In contrast, the survey of newsletter editors conducted by ChartCraft shows little change from last week. Tuesday’s results show 36% bulls and 37.1% bears - putting the two sides equally at odds. In early March, we saw a somewhat polarized sentiment. But as the rally unfolded, both the optimists and pessimists have been slowly approaching each other.

Howard Ruff
The 25% rally this past month has brought out the experts. And for the most part they are now back to their talking points. Take for example, Howard Ruff. He’s decidedly bearish as usual and saying that the recent move is just a bear market rally. He’s looking for hyperinflation and a “toxic” stock market for the foreseeable future.

On the other hand, the spasmodic Jim Cramer has declared the “the depression is over”. Never mind that it was just a few months ago that he asked people to leave the market for the next 5 years. And even shorter still when he promised by a gentleman’s handshake that Mad Money will feature a more rational host. The worst is over! And it is time to become a roaring bull (again). Cue the soundboard. Increase the props department’s budget!

The lesson here is to recognize the inherent bias in every source and to recalibrate what they say based on that. There are very, very few who are as easily bears as bulls and rather than swayed by a bias, rely on evidence based market analysis.

Rydex Traders
Two weeks ago, I mentioned in a similar sentiment overview that the itchy triggered Rydex traders have stampeded to the bull’s side. To put it bluntly, these traders are too excited for their own good and are positioned as they were at previous tops.

ISEE Sentiment
The ISEE sentiment index, which measures retail option traders, showed a consistent level of optimism all throughout this shortened trading week. Although never reaching spike highs (of 200+), the call-put ratio was noteworthy for the elevated plateau it reached. Here are ratios for the equity only ISE sentiment:

• Monday — 169
• Tuesday — 170
• Wednesday — 167
• Thursday — 174

The last time the ISE index spent 4 consecutive days above 167 was late last year, just as the S&P 500 reached a peak in early January 2009.

Follow the link for an update on the CBOE put call ratio (equity only).

Uptick Rule
The SEC is putting out feelers for a change to the rules governing a short sale. It wasn’t that long ago that the uptick rule was removed but there is now a real possibility that either it will be reinstated or some similar protocols will be put in place. From a sentiment perspective, the important thing is what people think about the change. If enough think that it will be a positive, it will be, irrespective of whether it truly is. This is the crazy, self-fulfilling effect that the market can have on itself - in the short term. In the long term, reality always reasserts itself like a wave of ice cold water.

Market Breadth
Persevering readers will remember that we’ve looked at market breadth a number of ways this week. Here’s another: the simple 25 day moving average of the Nasdaq daily advance decline statistics.
Continue reading ‘Sentiment Overview: Week Of April 10th, 2009′

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While we started to see a trickle of extreme bearish sentiment and some semblance of capitulation in last week’s sentiment overview, yesterday’s option market was shockingly and wildly bullish.

On the ISE, 201 calls were traded (to open) compared to 100 put options (equity only). Including ETF and indices options, that ratio jumps to 220. The CBOE (equity only) put call ratio fell to 0.60, almost confirming the same level of optimism. The last time the ISE sentiment index was above 200 was on the last trading day of 2008, which turned out to be a great contrarian signal:

But behind yesterday’s wildly optimistic ISE sentiment number, there’s a lot of nuance. So much in fact, that I’m afraid it leaves us with little meaning once we’ve explored it all:

For example, as I mentioned a few months ago, the ISEE index has settled into a narrow range. You can see by the yellow line in the chart above (representing the 10 day moving average) that this has for the most part continued.

You can see that in contrast to what we saw at New Year’s, the 10 day moving average is horizontal. I’m not sure what this narrow range means but it makes me uneasy to see this indicator behave so uncharacteristically to its past.

One possible reason why the options markets have been behaving so crazy is that the common stocks in the financial sector are mercilessly hammered, so the options on them become inexpensive lottery tickets. I’m not sure if there is a way to strip away option trades based on industry or sector so until then, this will remain a theory.

Another potential reason for the rare behavior of the ISE data is that more and more, traders are using leveraged ETFs to take directional bets on the market. These trading vehicles offer almost all the leverage of out-of-the-money options, without having a time value decay.

A final possible explanation is that the ISE is having some data issues. Although rare, I did catch an ISE data reporting error once before. Once again, I’ve looked over my data from them and noticed that somethings just don’t match. So I’ve emailed my contact at the exchange responsible for data integrity and hope to have this question settled at least.

Like all bear markets, it is incredibly difficult to read the cross-currents. Just staying in the game is winning at this point. Stay tuned as I’ll write an update when I clear this up with the guys over at the ISE.

I don’t know how some get the impression that I’m a perma-bull. I’m human, so by nature I’m biased. However, what I try to do always is to allow the tools and indicators to speak for themselves.

For example, on Wednesday (February 27th, 2008) I wrote a cautionary note that based on overbought breadth of both the Dow Jones Industrial and the S&P 500, the mini-rally wouldn’t keep up the pace.

My hunch was that we’d schlep around until it worked off and then head higher. But in any case, overbought is overbought. When you have both the indices showing 80% of their components trading above their 10 day moving average, you have to rein in the longs and bunker down.

Dive, Dive, Dive!
But instead of meandering, the market worked off its overbought breadth by nosediving. For those keeping count, the last time the S&P 500 was down hereabouts was in early February but the breadth numbers were washed out. We had only 20% of stocks in the S&P 500 trading above their 50 day moving average. Now we have 31%. We had a measly 17.5% above their 200 moving average. Now we have 21%.

My point is that the market has rolled over (again) without first getting really overbought in anything over than the shortest time frame possible - the aforementioned 10 day moving average. I don’t like that.

CBOE Put Call Ratio
Something else which bugs me is that on Thursday when the market fell a fraction of today’s move, the CBOE equity only put call ratio spiked to 1.0 (or for the obsessive compulsives: 0.966).

But today, when red filled trading stations the CBOE ended up falling! It closed at 0.836 if you can believe it. So according to this gauge, the option traders aren’t afraid - even in the face of a 2.5%+ decline

This is odd, and disconcerting. Yet, it is part and parcel of the mystery that is the market. These counter intuitive days when the put call ratio walks with the index are rare but they do occur. Sometimes they paint a bullish picture and other times not.

ISE Options Data
The ISEE index shows a more congruent picture with a dramatic decline in the number of calls relative to puts. Friday saw the ISEE index fall to 75 from 97.

That’s about as low as it got in mid February 2008 when the S&P 500 was trading slightly above Friday’s close. In contrast to the CBOE put call ratio, the ISE Index is saying that option sentiment is anything but apathetic.

Market Internals
How did we go from expecting a 90-90 up day to put a nice bow on the rally to getting a 90-90 down day? That’s what I’d like to know.

Maybe it was the short term overbought that I mentioned on Wednesday or maybe something else. In any case, we’ve been jarred from the slow and steady recovery from the January spike low with horrible market breadth.

Depending on which market data provider you use, we got anywhere between 2340 to 2400 declining issues on the Nasdaq and 2700+ on the NYSE. This has only been exceeded during this year on January 17th, when the market made its swing low.

Taking a quick glance at the graph of declining issues, I noticed that usually a low was carved out two to three trading sessions after such a spike high. Curious that it didn’t match such a wash out decline in breadth:

Hurts So Good
To leave on a positive note, the same short term indicator that that flashed a caution on Wednesday is now saying the opposite.

Of the 500 components of the Standards & Poor’s Index, only 13% are now above their 10 day moving average. This is low “enough” but if it happens to fall to less than 10%, without causing a concomitant fall in the indices, then the bulls are in for real a treat.

That’s because whenever we’ve had a similar deep oversold condition, even on such a short term time horizon, the market has rebounded strongly - see Lowry’s research.

Rundown of the usual and unusual sentiment measures for this most interesting trading week:

Hulbert Stock Newsletter Sentiment
The HSNSI measures the average stock market exposure among a subset of short-term market timing newsletters. As of yesterday’s close it reached -11.3%. Last week it was +8.6% when I pointed out that although that was low, usually we need to dip into negative territory. Its historic range extends from +79.7% to -81.8%. But the really negative stuff is for bear market bottoms.

Investor’s Intelligence
II’s bearishness has increased precipitously as the market has fallen. As the market topped they numbered around 22% but now they are 32.6%. That may not seem like a high number but relative to previous II readings, this is close to reaching its extreme. The bulls have likewise dropped from around 55% to 43.8%.

AAII
Puzzlingly the retail investors at the AAII have been very reluctant to become defensive. This week they finally inched their way into the bear side with 46% bears and 42% bulls. Although they’re going in the right direction, reducing bullishness by 4% points and increasing bearishness by 7% points, they haven’t really responded in the usual skittish way.

Market Vane
After I wrote about Market Vane last week, a reader pointed out that it may not be contrarian after all. They mentioned that in the past MV becomes bearish just as a major bear market or crash is about to occur. I’ve looked over the historical chart and I can’t really see this. Plus, they’ve already incrementally decreased their bearishness (by 2% points to 58%). So I’m still regarding this through a contrarian lense and see it as a bullish omen.

ISEE Call Put Ratio
As I pointed out although the ISE call put ratio didn’t reach a daily extreme reading, the ISEE index’s 10 day moving average did fall to historic lows seen only twice before. Things have been a bit wonky with the ISE and eventhough I’m pretty sure this data is accurate my trust has been eroded by their inexcusable lack of transparency and communication about their error.

CBOE Put Call Ratio
The traditional put call ratio (CBOE equity only) spent three days above 1.0 this week: Tuesday 1.08, Wednesday 1.05, Thursday 1.02 This is highly unusual and indicative of sustained fear. Obviously after today’s strong showing it declined to 0.75.

Conclusion
Although sentiment didn’t or hasn’t reached the kinds of extreme’s that I’d like to see at a significant market bottom, there is no question that we have pervasive bearishness out there. Here’s what appeared on the front page of digg this morning:

It linked to an article at Slate.com which in fact didn’t say anything remotely similar to the headline on digg. Nevertheless, it was dugg and made it to the front page. Perfect unorthodox contrarian indicator.

Did you find any other ones?