Trader’s Narrative

It is the end of the week and so we take a stroll through the sentiment meadows:

Investors Intelligence
This week the ChartCraft measure of stock newsletter editors sentiment was little changed from last week: 49.5% bullish and 23.1% bearish. That’s another week where twice as many are optimistic that the stock market will continue to rise. A remarkable long string of weeks but so far they have been correct.

AAII
The US retail investors meanwhile, as measured by the weekly AAII sentiment poll are slightly less confident. There was a 6% point fall to 41% bullish. And the opposing camp increased a smidgen to 36% bearish. All in all, this metric is slightly elevated towards too much optimism but still not enough to warrant our full attention.

Hulbert Stock Newsletter Sentiment
The Hulbert Stock Newsletter Sentiment Index (HSNSI) which measures a subset of newsletters which try to time the market continues to be muted. For the most part the HSNSI is showing skepticism in the face of the continuing rally. The HSNSI is about as bullish as it was back in April 2009 when the S&P 500 was trading at 800 - some 280 points lower. That is to say the average market exposure recommended by market timing newsletter is only 32.3% (long) - slightly lower (by 2.3% points) than what they were recommending 6 months ago. Such an unflappably consistent skepticism in the face of a gravity defying rally hardly gives the bears much ammunition.

Consumer Sentiment
The preliminary October results for the Reuters/University of Michigan consumer sentiment index fell to 69.4 (significantly lower than the consensus estimate at 73.4):

During economic contractions, the average Michigan consumer sentiment is 74. The average during economic expansions is 91. And on average when the S&P 500 has rallied 60% from a recessionary low, this consumer sentiment reading is 90.5. These historical patterns offer a remarkable contrast to where we are today - especially if we consider the often repeated mantra that we are in full blown recovery mode.

Option Traders
The 10 day simple average of the ISE sentiment index (equity only) call put ratio has an enviable track record - in the intermediate time frame. Almost every time it has reached 200, the stock market has meandered then stumbled. Not at all surprising since this implies that for the past 10 trading days, relative to puts, more than twice the number of calls have been purchased to open an options trade. Not once has the stock market been able to muster a significant rally when we’ve seen this metric reach such an extreme reading.

So it is important to sit up and take notice as this week the 10 day average for the equity only call put ratio floated up to 200 and on Thursday hit 202. During the relative short history for this sentiment metric, here are the few times where it has been above this mark:

The first was at the start of 2006 - the S&P 500 plateaued then fell into the summer. It wasn’t until September 2006 that it had reached a new high for the year.

The next instance was late in 2006. This was not the best signal since the market did manage to continue to climb momentarily. By March 2007 the S&P 500 was back at the same level.

Then it was May and October 2007 when the ISE’s 10 day average again touched 200. During that time frame the market did manage to push against the tide but over all it went nowhere. And we all know what happened after that.

CBOE Put Call Ratio
In contrast, the CBOE put call ratio (equity only) has recovered smartly from the call buying frenzy that we witnessed last week. Although we’re seeing the bulls reign in some of their enthusiasm for calls, it is important to note that from a long term perspective, we are still seeing a preponderance of hope and optimism rule the option pits:

Fund Flows
Last month we looked at the remarkable trend in fund flows for US retail mutual fund investors where even after a 60% rally in the S&P 500, the love affair with bonds continues at the expense of equity mutual funds.

Since then the same trend has more or less continued. Bond funds are still getting the majority of investors money but this week the ICI estimates they only got $8.80 billion (while last week it was almost double that at inflows of $15.21 billion). Equity outflows meanwhile have ameliorated with an estimated $3.39 billion being withdrawn for the week. This is down by about $1 billion from last week.

While a portion of this trend can be explained by the massive number of retail investors who are approaching retirement age, I can’t believe that that is the whole story. This bear market left a traumatic and indelible mark on those who lived through it, either as traders, investors, professionals or mere mortals. If this is true, then going forward, this means that we have to be very careful in how we calibrate our most trusted sentiment gauges.

Here is the round up of sentiment data for this week:

Sentiment Surveys
According to the weekly AAII sentiment survey, US retail investors are pretty much split evenly between the bullish and bearish camps. The bulls are at 42% ( that’s a 5% point increase from last week) while the bears are at 40% (4% point decrease from last week).

ChartCraft’s Investor Intelligence measure of stock newsletter editors has taken the bullish mantle from the retail investor’s survey for several weeks now. And it continues this week as well. The latest II poll shows the bulls commanding a 47.8% share of the respondents (down slightly from last week) and the bulls, 24.4%. The simple bear/bull ratio continues to run at about 2:1 - giving contrarians a clear signal.

German ZEW Survey of Investor Confidence
Turning our attention to the other side of the pond, the German ZEW sentiment survey of investor confidence (green line in chart below) came in slighly short of the 60 expectation but still managed to climb to 57.7 - its most bullish level since April 2006. However, the survey’s “current economic” outlook - while slightly off its recent lows - is still mired at historic depths (blue line):

This month’s survey results mark one of the few times in the history of this statistic where there is a large mismatch between the two measures. While the current economic situation is still deemed to be very poor, confidence in the future is very high. This should be familiar as it is the same tune that everyone is humming in the US markets. The question then is what happens if the rosy expectations of the future do not come about?

Option Traders
Both the CBOE put call ratio and the ISEE index are showing an excessive bullishness. This should be normal but since they have disagreed with one another so much, it made me sit up and take notice.

The CBOE put call ratio (equity only) dropped to a low of 0.45 earlier in the week (Wednesday - September 16th, 2009). That’s a lot of call buying! The short term moving average of the daily put call ratio continued to decline as it has for the past few months. It is already below its long term channel so it is difficult to determine what if any sort of signal it is giving now.

The ISEE index (equity only) meanwhile jumped to 242 on Wednesday’s long range candlestick. That means for every 100 puts, 242 calls were bought (to initiate a position). To find a more bullish one day statistic, we’d have to hop into our time machine and travel back to November 6th, 2007 when the ISEE index hit 245. At that time the S&P 500 was trading around the 1500 level. More important than just the one day spike, the 10 day moving average for the ISEE is now also significantly high as shown on the chart below:
Continue reading ‘Sentiment Overview: Week Of September 18th, 2009′

Here is this week’s summary of stock market sentiment happenings:

Sentiment Surveys
Even as the stock market bounced higher, the US retail investors, as measured by the AAII weekly sentiment survey, grew slightly more cautious. This week’s survey showed an increase of bears by 6% points to 44% and a small decrease in bulls to 37%. This is an intriguing turn of events, especially considering that just a short while ago, more than half of this same group of investors was extremely bullish. But just a small pothole on the way to higher stock prices has spooked them to not only grow less bullish very quickly but to also remain so. But there is anecdotal evidence that they are tip-toeing back into the stock market.

In contrast, newsletter editors as measured by ChartCraft’s Investors Intelligence sentiment index continues to be wildly bullish with optimists outnumbering pessimists 2 to 1. This week the bulls diminished slightly to 23.6% and the bulls also shrank a little bit to 48.2%.

And finally, the Hulbert Stock Newsletter Sentiment index shows that the small subset of market timing newsletter editors tracked by the Hulbert Digest have not materially changed their posture. But the Hulbert Nasdaq Newsletter Sentiment index has registered a serious decrease in optimism. This sentiment measure was 57.1% on August 21st, 2009 when the Nasdaq was at 2020. Meanwhile, today the Nasdaq closed almost 61 points higher, but the HNNSI is just 28.6% - almost exactly halved.

We’ve been witness to a schizophrenic sentiment outlook recently. This choppy, one day bullish, the next day bearish, and then back again type of action is usually characteristic of corrections. Such lack of conviction, with everyone ready to switch camps at the drop of a hat makes me think that one side will eventually be caught on the ‘wrong’ side of the market. And their pain will fuel the next leg, either up or down. Honestly, right now I’m not convinced myself which is more likely. I’ll prefer to be in the audience until the fog lifts.

September’s Seasonality
True to form, with everyone’s attention directed towards the dire September seasonality, the market has staged a rocket-ride higher!

Consumer Confidence
The Reuters/Michigan University consumer confidence data released today rose above 70 again. The last time it was in the vicinity of this area was a few months ago in June.

Both the current conditions index and the expectations index rose from August. Either the average US consumer is simply believing the stock market’s message or the US economy is actually getting better.

The consumer confidence survey from Gallup also shows a similar increase (see chart on the left). In fact, the current level is the highest consumer confidence level since they started to track this question at the start of 2008.

Option Traders
Thursday’s one day ISE sentiment (equity only) index was 210 - meaning that there were 210 equity calls purchased by retail clients for every 100 puts. That’s the highest level since July 28th, 2009 when the S&P 500 was at 980 - some 70 points lower. But that’s just a one day super-bullish event so it has little consequence, especially as the ISE index fell hard on Friday (to 137). The short term (10 day) moving average is much more meaningful and it is at 171 which leaves it mired in neutral historical territory.

The CBOE put call ratio (equity only) continues to register very strong bullish sentiment:

The short term moving average is still at a very low level and it is also well under the multi-year channel line. It is certainly possible that this ratio can continue to be mired in this area for some time. The CBOE put call ratio is eve more bullish that it was at the beginning of 2007.

Lighting the Afterburners
This week we saw an incredibly powerful thrust in the markets with pretty much every single issue out there moving up. While this following data point is not technically a sentiment measure, it is definitely a consequence of the return of risk taking on Wall Street: this week saw more than 3 out of every 4 NYSE issue trade higher. This is, needless to say, a rare moment in market history. On the flip side, you’ll recall that earlier in the week Wayne pointed out the incidence of zero new lows in the NYSE.

Below is this past week’s summary of sentiment data:

AAII
According to the American Association of Individual Investors, the average retail investor in the US is down right giddy. This week the bears declined by 2% points to number just 33%. The bulls meanwhile managed to eke out a tiny 1% point increase from last week to reach 51%. Anytime we see the magical 50% mark in either camp, I take special notice.

To find a higher level of bullishness, we have to go back to May 2008. For the week of early May 2008, the AAII survey showed 53% bullishness. In that sentiment overview, I wrote:

There is no way we can discount or ignore this. Such a high level of bullishness is downright frightening - from a contrarian point of view.

When I wrote the above, the S&P 500 was trading around 1410. In a few weeks it had managed to peek over 1420. But that was it. If you were looking or a sign that the market rally had petered out, you would have a hard time finding a better one. By July 2008 it had fallen to 1200 and by November to 750. As well, this level of bullishness is extra noteworthy because it was at this level of optimism on October 2007 that the stock market topped and entered into its current bear market.

In the same way, I think today, if this single data point doesn’t make you run for the door, it should at least be making you eye the exits warily. While the retail investor has been building back their confidence throughout this rally, their increasing bullishness will inevitably reach a climax point. Here’s a chart showing the last 3 times that the AAII sentiment was so optimistically lopsided that at least 50% were bullish:

Continue reading ‘Sentiment Overview: Week Of August 14th, 2009′

The following is a run down of this past week’s sentiment data:

Sentiment Surveys
Let’s start by looking over some of the well known sentiment surveys:

The retail investors sentiment as measured by the AAII survey was equally balanced with bears and bulls both at 39% - and the rest undecided. To arrive at the tie, the bullish camp shrank by 9% points and the bears increased minimally (2% points).

ChartCraft’s Investors Intelligence continued to grow more bullish this week with 47.7% bulls and 23.3% bears (with the rest neutral). That’s more than twice as many bulls as bears! The last time we had this much optimism from this measure of newsletter editors’ sentiment was in December 2007. Interestingly enough, the S&P 500 back then was trying to get above its 200 day moving average - it didn’t succeed for too many days.

The Hulbert Stock Newsletter Sentiment Index (HSNSI) confirms the II data showing that the average equity exposure has increased by 60% points since early March 2009. Although some shift in sentiment is normal at the end of a bear market, this is double the average increase in the first 3 months of previous bull markets.

Rydex Ratio
We haven’t looked at the fast money traders in Rydex mutual funds. They have recovered from the March extremes but we are a ways yet from reaching the other side of the graph:

Option Traders

The CBOE put call ratio (equity only) fell to 0.55 on Thursday. That is a level which, while not being an extreme low, is low enough to show considerable confidence in the stock market. In effect, there were almost twice as many calls traded as puts (twice as many bets that the market would go up, as opposed to down). Other than this small blip, the larger picture hasn’t changed much since the last chart I featured in the sentiment overview last month.

The ISEE Sentiment data was even more lukewarm, offering no real clues from a contrarian perspective. The ISE equity only call put ratio was 191 which is relatively high. But we’ve seen a few isolated instances at this level before and it hasn’t been enough to stop prices from rising.

Hedge Funds
The latest data from Hedge Fund Research shows the average hedge fund 45% net long (as of May 19th 2009). That’s up from 33% earlier in the year but not as long as one year ago. The good news for the bulls is that there is still a lot of dry powder in hedge-land waiting to be deployed (especially if the market keeps going up and forces hedge fund traders to get off the fence). The bad news is that the so called ’smart money’ hasn’t really believed in this rally… yet.