Trader’s Narrative

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′

After reaching an all time low in January 2009, the Conference Board Consumer Confidence Index reached an all time low (again) in February 2009.

Although we haven’t seen such a dramatic fall in this metric for 42 years, historically, such troughs are signs of the coming of better times in the stock market. In fact, along with several other variables, gloomy consumer sentiment is one of the handful of conditions of a new bull market.

Now we are seeing an almost equally forceful recovery with the latest Consumer Index data from the Conference Board:

The last time we saw this kind of jump in the Consumer Confidence was in early 2003 - coinciding with the bear market’s end. The stock market certainly cheered when the surprisingly higher number was released by the Conference Board on Tuesday. And it is confirmed by other sources like the Gallup poll of US consumers showing a marked improvement since February 2009:

Source: Gallup Consumer Poll

So the question is, is such a sharp recovery in consumer optimism bullish for the market? or bearish?

In a recent column, Mark Hulbert argues that it is bearish. He compared the index with subsequent stock market returns (month, quarter, year, and 2 year periods). The relationship Hulbert found was an inverse one, where falls in Consumer Confidence lead to rallies in the market (and recoveries in Confidence lead to lower returns in the stock market). Given the contrarian nature of the crowd, this isn’t surprising.

But it isn’t the whole story.

James Stack, editor of the InvesTech newsletter and Jason Goepfert of SentimenTrader both focus on something entirely different. The Conference Board releases several different sub-sets of data. The one most people concentrate on is the Present Situations number but there is also the Expectations Index, which asks the respondents to look ahead to 6 months in the future:

They both keep track of another variable: the Expectations minus the Present Situation Index - in other words, the difference between how consumers think they will fare in the future and how they are doing right now. And interestingly enough, this net variable is actually positively correlated to the stock market - and a leading indicator.

I highly recommend both sources. To see the net Confidence chart take up their free trial offers:

You can get a free 14 day free trial of SentimenTrader.

And you can get a free sample of InvesTech’s newest report here.

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.

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.

The National Federation of Independent Business (NFIB) Small Business Optimism Index fell 2.6 points to 85.2 in December 2008:

This is an aggregate measure of 10 indicators: outlook for expansion, earnings, sales, and hiring. Amazingly, the net percentage of small business owners planning to hire is -6%. That scrapes the bottom of the barrel and is analogous to the recession we saw back in the 1970’s (not shown on graph).

Small businesses are often been touted as the engine of the US economy. From this survey it is obvious that the engine is flat out junked. These numbers are as bad as we’ve ever seen them in modern history.

The NFIB survey complements the other sentiment readings we’ve been getting from other sources such as the Conference Board Consumer Confidence and the State Street Investor Confidence Index.

You can get more information and download the full report at the NFIB site.