Trader’s Narrative

We stared into the abyss and staring back at us was this week’s sentiment overview:

Investor’s Intelligence
I mentioned in last week’s sentiment overview the surprising bearishness of newsletter writers as measured by Chartcraft. This week they have outdone themselves with an eye popping 44.7% bearish level.

To find this sentiment equally or more pessimistic, we’d have to go all the way back… are you ready? to 1998.

Which, if you are old enough to remember (or agile enough to look up) was a time of unprecedented market turmoil brought on by a gaggle of PhD’s from Chicago running a little hedge fund called Long Term Capital Management. Back then, the II bears reached 50%.

Hulbert Newsletters Sentiment
According to Mark Hulbert, the stock market newsletters with the best long term track record are much more bullish compared to those with a track record worse than buy and hold. They in turn are suggesting being short this market. So which side do you want to be on? Of course, a track record doesn’t guarantee anything except experience. But considering the dearth of other measures which point to a bottoming process, it isn’t too hard to see this as another corroborating indicator.

Optionland
The CBOE equity only put call ratio has backed off its spike high - reached earlier this month. This is normal behavior for this indicator as the market now tries to pull itself up by the britches.

The ISE Sentiment index on the other hand, never really reached extreme levels during last week’s close call with the January bottom. To be honest, I had been watching it in case it did because that would have signaled that the retain option traders were giving up any hope of a bounce off those levels.

Magazine Cover
Here is the current Economist magazine cover:

Although it is decidedly negative, I don’t think it reflects anything more than what is really going on on Wall St. right now.

Subdued VIX
Although volatility, as defined by price movement in either direction, has been truly volatile, the VIX has refused to pierce 36 as it has in the past instances of market declines.

Part of me would like to see the VIX spike to crazy levels but I also have to remind myself that not all market bottoms are alike. As they say, the past rhymes, it doesn’t repeat.

So while it would be nice to have this yet another indicator among the myriad we already have, it isn’t really necessary. And perhaps there are structural reasons for this that will persist even after this current turmoil.

Repo Market Failures
There was such a mad dash for safety that the repo market seized up after record failures to deliver collateral - US government treasuries. Rates also scraped the bottom of the barrel at 0.38%! And I thought the rates a few days ago at 0.92% were low.

I mentioned that the Fed is still way behind the curve (even after the recent rate cut). This is illustrated by the gap between the 3 month Treasury Bill and the Fed Funds rate. As well, so far this year, the general collateral rate (rate for borrowing/lending US Treasuries) has been on averaged 63 basis points lower than the Fed’s overnight target rate. That is in comparison to only 8 basis points in past decade.

See my point now? There is no doubt that the Fed has exacerbated this situation by refusing to get ahead of the repo/bond market.

Here’s this week’s sentiment commentary:

Sentiment Surveys
LowRisk is showing the most positive picture with bulls falling to 29.4%. In contrast, AAII bulls are at 49% and the II bulls at 55.6%. I don’t know about you but I’ll take the latter surveys over the one exception.

It isn’t surprising to see the AAII bulls jump so high, so fast. After all, even in the darkest days of August, their pessimism was guarded. They never really got spooked. Now that the market has recovered, they’ve jumped on again. From a contrarian perspective, that doesn’t bode well for the market going forward.

Narrow Range & Low Volatility
Since I suggested to sell something, the market has entered a narrow range, meandering with no conviction. The rhythm of the markets is such that expansion tends to be followed by contraction. Just as you need to breath out, before you can breath in again.

Volatility (VIX) which spiked to 37.50 just a month ago has collapsed to less than half. That doesn’t automatically mean that the market can’t continue to climb. Remember, low volatility has no correlation to market behaviour (as opposed to volatility spikes). What it does tell us is that the low risk opportunity to buy was back then when the VIX spiked, not here — click to see a long term chart of the relative VIX index.

Magazine Cover Indicator
Here is this week’s Economist magazine. The gun has an inscription “Made in America” - implying that the credit crisis began in the US and as the trigger is being pulled, it will “trigger” a new downturn. At least, that is the question the cover is asking rhetorically.

There is no question that this cover is negative but the metaphor of a gun being pulled is a bit awkward so I’m not sure if it qualifies as one of the classic magazine cover indicators.

In any case, as a contrarian indicator, I would interpret this mildly bullish for the market and for the whole credit mess. I think the worst is behind us. The market still needs to mop up the mess and that will take time, but it doesn’t make sense to wallow in fear and loathing about something when it is on the cover of magazines and when journalists are writing related articles at the fastest clip ever.

In poker, you have to know and watch for “tells”. These are habitual behaviours or reflexive actions of opponents. By watching for them you can know whether they are bluffing (or not). The same type of “tells” exist in the stock market.

As can be seen in the relative strength chart (see below) Apple (AAPL) has been one of the strongest stocks throughout this bull market. It shrugged off the March 2007 correction and kept on barrelling ahead. For me, AAPL is a “tell” for the current market.

All the smart and “hot” money has been trading it and riding it higher. And you can bet they will run for the exit at the first sign that the party is over. Which is why I watch Apple so closely. I’m seeing a confluence of things which gives me reason to believe that the ride may be over.

For one, the sentiment picture is just too bright. Take a look at this recent Economist magazine cover page. Although I’d prefer to see such a glowing cover story on a more general magazine like, say, Business Week, it still is a cover page. The last time I pointed out an Economist coverpage was the one they did for Goldman Sachs (GS). That one did a fine job of alerting GS longs to take profits and go home.

The other reason is the upcoming launch of the iPhone. As the old adage goes on Wall Street, Buy the rumour, sell the news. The closer we come to the June 29th launch of the much hyped iPhone, the higher the expectations. And the easier to fall short of them.

Also a bunch of technical indicators are signalling caution. For one, look at the lofty heights that Apple is trading relative to its long term (200 day) moving average. The last time it was at this level was in January 2006. And you know what happened then.

As well, if you draw trendlines on its chart, you’ll notice that for its latest upleg it has basically gone parabolic. Such a steep rise is simply not sustainable for more than a few weeks to a few months maximum.

Now, some may be looking at the relative strength and thinking that you should always buy strength. But its not that easy. It never is. The last time it peaked, relative strength also looked good. But that didn’t last. And if you notice, during that upleg it was also going parabolic.

Finally, today’s action seems ominous. It was a a wide range engulfing candlestick which took price down 3.5%. I had been meaning to write this post during the weekend but forgot. But even if you missed today’s move, there’s ample room to tighten stops on Apple.

I don’t think it is an automatic short here since it could very well go into a protracted range and work out its overbought condition. But if you’re long, I’d be very careful here.