Trader’s Narrative

Sentiment Surveys
For the past few sentiment overviews, I’ve been bemoaning the lack of bearishness from retail investors. According to the AAII weekly survey, we did see a huge spike up to 60% bearishness, but then a very quick nonchallant attitude took over Mom and Pop investors across the land. For some strange reason, as the bear continued to maul markets with blood curdling ferocity, they didn’t care. Or maybe they were numb from shock already.

It was not surprising then that the market broke through the October and November lows. This week’s AAII numbers show an increase in fear (finally!). It is important to note that they came in on Wednesday - before the elevator drop through previous support levels - so it is curious to guesstimate where sentiment would be if the survey was administered afterwards.

AAII bulls came in at 24.37% and the bears at 57.14%. While this is a good development, as I’ve said for the Nth time, what we really need to see is the market recover and a commensurate increase (or plateau) in bearish sentiment. That would give me confidence in any ensuing rally. But if once again people start clinging to every uptick as a hopeful recovery, it will be short lived.

ChartCraft’s Investor’s Intelligence sentiment measure was mostly unchanged with 31% bulls (a tiny decrease) and 43.6% bears (slight bump up from last week). This survey came out on November 18th and it continues the slow trending decrease in bearishness from October.

Of course, the completely useless Citigroup Panic Euphoria model continued to impersonate a dead parrot’s heartbeat monitor. If Vikram wants to cut costs at Citigroup (C), he could start at worse places.

Market Vane’s bullish consensus sentiment dropped slightly to 40%. During this downturn this measure of sentiment has also stubbornly remained above previous panic levels. The lowest it reached was 32%, a far cry from the 20% range we saw in the darkest hour of the previous bear market.

Options Market
The options market continues to confound. While the CBOE equity only put call ratio increased to 1.16 as a result of Wednesday’s 6.12% plunge in the S&P 500, the next day’s carnage which took the index down 6.7% actually saw the put call ratio fall to 1.05.

The same pattern was noticeable in the ISE Sentiment index. The ISE call put ratio fell to 78 on November 19th - low but not extreme - but then it rebounded the next day even as the market took a more intense drubbing.

The options market continues to act crazy. Although put call ratios don’t walk hand in hand with the market every day, this is just bonkers. It is almost as if we’ve entered an alternative universe where previous market indicators and measures mean nothing.

Volatility
Volatility hasn’t imploded (yet). In fact, the VIX is back at previous highs last seen in late October. The thin layer of good news may be that while the market has broken to new lows, volatility hasn’t.

It wasn’t long ago when 45 was considered “extreme”. Since mid October the VIX has stayed above “extreme” and redefined it. Beforehand, we had broken above 45 on only four occasions. So yes, this is an absolutely unprecedented market.

Value Investors Peek Out
The ever cautious head of Fairfax Holdings (FFH), Prem Watsa, has peeked from under the covers and decided to remove the protective hedges for the firm’s equity portfolio. While Fairfax still holds the bulk of their assets in fixed income, it is another sign of valuations coming to attractive levels. Watsa is compared by some to Buffett because of his cautious nature and his strict adherence to a value oriented investment philosophy.

Watsa wrote to Fairfax shareholders: “While we believe the recession may be long and deep, we also believe that stock prices may have already discounted the worst of the economic decline. As value investors, we are finding an incredible number of investment opportunities across the world. That said, in the short term we recognize that stock markets can continue to fall significantly.”

To get similar news, watch news.tradersnarrative.com - that’s where I put links to interesting articles, breaking news, reports, etc.

Here is this week’s stock market sentiment overview:

Sentiment Surveys
In last week’s sentiment overview, ChartCraft’s Investor’s Intelligence sentiment survey came in at a 14 year low (for bullishness). This week there were only 22.4% bulls with bearishness remaining unchanged. This week’s numbers take the II to a 20 year record! From a contrarian point of view, the message is clear.

The AAII sentiment survey is whistling a different tune however. The bears fell dramatically from 61% to 40% and the bulls rose to 41%. That’s a dramatic shift. Not only for the decrease in bears but because technically we now have slightly more optimists than pessimists. For confirmation of a market bottom and a healthy rally, I’d prefer to see continued doom and gloom.

There was a similar uplift in mood for the Consensus sentiment survey. Bullish sentiment rose from last week’s 21% to 36%. Again, not the sort of thing that gives contrarians confidence for a sustainable rally.

Volatility
Now this is just insane. The VIX closed the week at 70.33 - that is a record, in case you’re keeping track. But a new all time high record isn’t what makes my eyebrows levitate. It is that the VIX ended higher than on October 10th 2008 - when the market closed lower than on Friday. So while the market is now higher, fear - as measured by the VIX - is actually more pronounced. Interesting.

TED Spread & LIBOR
The credit markets are continuing to thaw with both LIBOR and the TED spread falling. But, and that is a big but, we are no where near normalcy. Both indicators are at extremely elevated levels. They difference is that they are now going in the “right” direction (if you are a bull). But they still have a long ways to go to totally unwind.

Sell Side Indicator
The Sell-Side indicator measures the equity allocation recommendation of the average Wall St. strategist to their clients. As you can imagine, as a group they are a great contrarian indicator just like the newsletter editors (Investor’s Intelligence) or the retail investors (AAII). Here’s a good article which explains it in more detail.

Right now the average allocation is 58% - which is the lowest level in 10 years. However, if you look back more than that, it is clear that we are near levels which would only suggest a cyclical bottom for the stock market, not a secular one (at best):

University of Michigan Sentiment Survey
If we needed another sign that the US consumer is totally pessimistic, the recent Michigan sentiment survey shows an even lower reading than the last time I mentioned it in May (Conditions of a New Bull Market: Consumer Sentiment). At 57.5%, it is now lower than anything we’ve seen in almost 30 years. This is saying a lot when you consider all the shocks that the financial markets have been buffeted with over that time:

The lowest reading in the history of the survey was in May 1980, 51.7%. This most recent result is preliminary and may be changed when it is finalized on October 31st 2008. We actually saw a lower reading than this most recent number in June 2008 with 56.4%. Then things seemed to improve to 70.3% only to fall down again. In any case, these small details matter less than the overall picture showing a shell-shocked consumer.

As you’d imagine, in the upside down world of contrarian sentiment, extremely pessimistic consumer sentiment is bullish.

Hedge Fund Redemptions
Forget mutual fund redemptions, hedge funds, the sophisticated investment vehicles of wealthy individuals and institutions is hemorrhaging assets to the tune of $210 billion. It seems most aren’t absolute return vehicles but closed index funds because in the recent quarter, they produced terrible results for their clients. According to hedge fund watchers, this looks to be the worst year both in terms of asset flows and returns.

Of course, not all hedge funds suffered. Andrew Lahde posted +860& returns and closed shop after just one year.

According to seasonality, we are coming into the time of the year when it has historically been a good time to be long bonds:

But seasonality isn’t everything. It is only one piece of the puzzle and even at that, it is anaverage of many years, smoothing out the year to year volatilities.

I disagree with it this year and don’t think right now is a good time to be long bonds. There are several reasons. For one, the sentiment regarding bonds isn’t gloomy enough. The AAII bond allocation is too high for my liking and the Consensus survey is showing way too many bulls (72%) compared to almost 25% last summer - when bonds finally got bids.

Also bond prices have simply come too far, too fast for me to realistically expect them to continue their pace. Looking at a 6+ historical chart, they have just descended from some very thin air territory. And with the exception of a short term buy signal in February (green arrow), they have a much higher chance of falling from here than rising.

That buy signal by the way, was a consequence of the stock market turmoil which caused people to take sell stocks and take ‘refuge’ in bonds.

The blue arrows mark the month of May in each year when bond seasonality turns positive.

Everything seemed to be going alright and then GE came along and whacked the markets with their largest earnings miss in at least three years.

Any way you cut it, Friday was a horrible day (for the bulls). There were 2440 issues declining on the NYSE (out of 3211) and on the Nasdaq, 2,290 fell out of 3,037 traded. Advancing volume was dwarfed by declining volume - 9:1 on the NYSE and 6:1 on the Nasdaq.

Of course, I don’t think that GE is the real cause of the market’s fall but it is a comfortable excuse for most. I outlined my hesitation that the market was approaching resistance levels and that the odd lot short sales were too high to give me reason to believe that the rally would continue.

Surveys
According to Investor’s Intelligence, newsletter editors are for the most part unchanged in their view of the market. Meanwhile, the AAII sentiment has now recovered that it is slowly approaching just a tad too much optimism: 46% bullish, 37% bearish.

The same can more or less be said for the other sentiment measures: LowRisk, Consensus, and MarketVane, so I won’t bore you with their mundane details.

Put Call Ratios
The decline wasn’t enough to push the CBOE put call ratio to parity. It climbed to just barely below 0.90 - below levels which we would associate with panic:

Before Friday’s thrashing, the small option traders as measured by the proprietary ROBO ratio had actually increased their pessimism despite the market’s recent rise. I always take notice whenever sentiment goes in the opposite direction of the market it is tracking. But again, this was before GE threw a monkey wrench into the works.

NFIB Sentiment
The National Federation of Independent Business (NFIB) is reporting that small business sentiment in the US is at an historic low. They have collected information from their small business members for more than twenty years and this most recent response is the gloomiest assessment of business outlook ever.

So it seems that the horrendous consumer sentiment has company.

As you would no doubt surmise, such pessimism is actually good for the market. Whenever we have an excessive level of doom and gloom, the worst is already behind us. I’m referring to the stock market here because while there may be real pressure on consumers and small businesses, the stock market is a forward discounting mechanism.

And because it looks forward while other indicators measure the past or present, it can seem to be paradoxically the opposite of the real economy.

Alright, before we start the new trading week, here is the sentiment overview of the concluding week. There is little to write about because little has changed since the previous overview:

Sentiment Surveys
According to Investor’s Intelligence, newsletter editors are pretty much were they were when we did an overview of sentiment last week. With 36% bullish and 37% bearish, we continue to have very good grounds for a rally.

Similarly, the AAII survey shows 37% bullish and 39% bearish. It is interesting to see these two (II and AAII) sentiment gauges now paralleling each other. It wasn’t that long ago that they were sending mixed messages and everyone, including me, was trying to make sense of it.

Consensus, which was showing the lowest bullish readings since 5 years ago, recovered to 27% but is still in extremely bullish territory.

Odd Lot Short Sales
One indicator which is blinking red against the bullish scenario is the NYSE odd lot short sales. These are small amounts of stocks which have been sold short. Since retail investors or traders are usually behind these, it is safe to assume that no complex hedging strategy is behind it. But rather, their expectation is that the market will fall.

Recent data shows the odd lot short sale approaching levels which have previously marked a top. But the good news is that this indicator is very short term in time horizon. We’re talking days or weeks at the most here. Which is hardly surprising considering where we are:

Right below the tenacious resistance levels at 1400 which have repelled previous rallies. I don’t pretend to know where the market is headed but the best case for the bulls would be a pause just under that resistance level, and then another assault to break through the barrier and go higher.

If you squint you may notice that there are technically lower highs and lower lows. Of course we have the December 2007 swing high, then the early February 2008 top, followed by the late February 2008 top, and then finally where we are now. If it turns into another top… well, that would be very messy for the best laid bullish plans.

Doom & Gloom
Here’s an interesting headline from ABC News: “Are We Heading Into a Depression?” It juxtaposes the infamous image of the depression in our minds with that of today.

Before you rush out to buy cans of preserves and stock-up on cheese, remember that it is much easier for the media to sell fear and gloom than positive news. And that from a contrarian perspective, such bombastic headlines are actually precursors of better times ahead.

And by no means is the above example an isolated case. The media is replete with such stories. Just a few days ago I showed a BusinessWeek article which immediately called into question the nascent recovery in the stock market.