Trader’s Narrative

Here’s this past week’s sentiment data:

Sentiment Surveys
Investor’s Intelligence (measuring the newsletter editors market bias) is showing a surprising amount of bullishness at 56.5%. This is a slight increase from last week. The II bears fell slightly to 22.4%.

In contrast to newsletter editors, the AAII survey (measuring retail investors) is showing only 36% bulls and 47% bears. Since last week the bears increased by approximately the same amount the AAII bulls decreased.

Although odd, this isn’t the first time these two sentiment surveys have been at loggerheads with each other.

Fund Flows
According to AMG Data, US mutual fund investors withdrew $15+ Billion from equity mutual funds (not including ETFs). Most of that was from domestic funds and the remaining from foreign funds.

This is HUGE!! I can’t really understand what is going on or even if this statistic is correct. If it is, it is larger than any weekly withdrawal for more than 6 years. It is even larger than what we saw in the darkest days of the 2002 bear market. Wow!

Some portion of this gargantuan number is due to the year end effect when mutual fund investors have their last opportunity to square things tax-wise. But as I already pointed out, this is nothing like we’ve seen in previous year end tax selling. Something big is going on. Obviously when people are selling their equity investments at such a torrent, it is wiser to exit the crowd or even fade it.

State Street Investor Confidence:

State Street is one of the largest financial firms in the world. They have a unique sentiment measure which relies on aggregate data from their position as custodians for investment managers:

Unlike other survey-based confidence measures that focus on expectations for future prices and returns, the Index provides a quantitative measure of the actual and changing levels of risk contained in investment portfolios representing about 15% of the world’s tradable assets.

The interesting thing is that this month, the State Street Investor Confidence Index plumbed depths which it had never seen in its entire history!

If you want to get more info on this sentiment indicator as well as full historical data (monthly), check out the FREE Trading Resource section (under Reports & Articles). While you’re there, be careful or you might find other interesting stuff to busy you for hours

The trend in the fund flows data continues. Investors are shunning the US stock market and embracing the international equity markets.

According to AMG Data: for the month of May 2007, domestic funds reported an outflow of $5.2 billion while non-domestic funds report net inflows of $11.6 billion.

For the month of June 2007, domestic funds report net outflows of $4.2 billion while non-domestic funds report net inflows of $9.3 billion.

The only other market which is even close to as unloved as the US is the Japanese market. Every other market, emerging and developed gets some love (aka capital).

While this dovetails nicely with the other data suggesting the retail investor’s apathy towards the US stock market, in the long run it can’t be good. Typically, a bull market starts out with everyone being skeptical and ends when no one is.

But the market needs the participation of the regular guy. Right now we are seeing the “smart money”, commercials falling over themselves to get long. This is a fantastic vote of confidence in the intermediate to long term. But they can’t sustain the market forever.

While sentiment data and my proprietary sheeple index are interesting, they are both circumstantial evidence.

To see what people are actually doing, we have to look at funds flow or liquidity data. The last time I brought this up was last summer when a skittish public started pulling out significant funds as a result of a small correction in the markets. That had panic written all over it and as a contrarian, one would interpret it as bullish since it took very little to scare people enough to have them pull money out.

Right now we aren’t seeing that sort of fear in the market. However, as we have come to suspect from the other evidence (sentiment and traffic data of online brokers), the retail investors are not believers in the US markets. In fact, they are putting money to work everywhere and anywhere except the US markets.

According to AMG Data: Last week, for data including ETFs, investors pulled $1.6 billion out of the US markets and in contrast, sent around $700 million to work in non-domestic destinations. In April domestic funds saw net outflows of -$4.9 billion while non-domestic funds reported net inflows of $20.2 billion.

So while the average investor is shunning the US markets, they are hitting within spitting distance of all time highs. Interesting. Where are they putting their money? In the emerging markets: Asia (except Japan), Latin America (especially Brazil and Mexico), Russia and Western Europe.

In the face of such evidence, I wonder how people can continue to call this market “frothy”? or the price action, “a melt up”?

But although funds flow data is an accurate and meaningful gauge, it must be approached wtih the right time frame. As the example from last summer, it works great when you have a medium to long term point of view. Anything shorter and it isn’t really helpful.

While a bull market requires active participation by the retail investor, today it is the private-equity sector who is the primary force behind the demand for equities. Every day we read about one large deal either rumoured, announced or concluded. My take is that as the market moves higher, the retail investors will ultimately succumb and start to buy stocks again. And finally, as in all cycles, in the later stages we’ll have a real “melt up” and “froth” as the masses rush to invest in a hot market.

But until then, we’ve got a long ways to go.