Trader’s Narrative

Money tends to get shuffled around from place to place and hand to hand.

Within the financial markets the big three boxes are stocks, bonds and cash. When the bets are placed, over time, the retail traders tend to lose and the deep pocketed, well informed institutional traders tend to win.

So by looking at where the retail traders are placing their bets, we can get an idea of where to not place ours.

AAII Allocation Data
The American Association of Individual Investors (AAII) is famous among those who track sentiment for their weekly survey. But they also keep track of several other key data points. Among them is the allocation ratio of their members between cash, bonds and stocks.

From the latest data, AAII respondents have said that they have increased their cash positions to almost a third of their portfolio value. This is the highest cash levels since late 2005 and 2002. To raise the cash allocation, retail investors have sold their equity holdings.

In comparison to the summer of 2007 when the allocation for equities was almost 70%, today it is just above 50%. To find similar levels we’d have to go back to November 2005, summer of 2002 and May of 2003. Each of those instances were great buy points with a long-term time horizon.

But remember, this is as reported by the membership of the AAII. There is no way for them to verify if indeed what their members are reporting about their allocations is true. So let’s take a look at actual fund flow data.

Fund Flows Data
According to AMD Data, July’s money market funds reports net cash inflows totaling $44.402 billion! That is a very large amount for one month.

Back in April, I pointed out the reverse: a massive exodus from money market funds to the tune of almost $80 billion. Since then the average mutual fund investor has consistently increased their cash position - which would tend to lend credence to the AAII survey results.

Caveat Trader!
The market always throws curve-balls to keep things unpredictable and exciting. So remember, retail traders are not always wrong.

Sentiment Surveys
No significant change within the usual sentiment surveys. Both the AAII and II moved just 1% points: the AII going to 47% bulls from 46% and the Investor’s Intelligence bullish percent from 45% to 46%.

Hulbert Newsletter Sentiment
According to Mark Hulbert, out of 10 market timing newsletters with the best risk adjusted performance, seven are bullish right now. Among the ten, their average equity allocation is a whopping 78%! This is especially meaningful when compared with what the worst market timers are saying: an equity allocation of just 11%.

So unless you think that all of a sudden the pattern of performance is going to be upended, this is a very bullish sign for the market.

ISE Sentiment
We got a surprising uptick in the ISE Sentiment index this past week. On Thursday it peaked at 192. To provide some perspective, on October 8th, 2008 the ISE sentiment index reached 279 and on October 29th 2008 it reached 275. The October swing high of around 1560 was put in between these two dates.

And finally in mid May, when the market made its swing top, the ISE sentiment was 225. We didn’t really approach record highs for this measure but usually anything around 200 shows significant risk aversion (the ISEE sentiment is a ratio of calls to puts).

LowRisk Sentiment
A few people contacted me asking about LowRisk and as I mentioned before I haven’t received any response from Jeff Walker after inquiring about LowRisk. Their site continues to be stuck on March data with no updates as of yet. Unfortunately, it looks like this sentiment measure is no more.

So more or less we continue to muddle through with lukewarm sentiment on average. I continue to see the March bottom however, as significant and these counter currents we’ve seen lately don’t necessarily negate that.

The two major groups in the stock market have been and will always continue to be large, well capitalized and well informed “insiders”; and the small, underfunded, emotional, ignorant retail investors and traders.

These two groups engage in a financial dance which invariably concludes in the long term with one group enriching the second. Although they usually don’t take such contrasting positions, at times they can mirror each other.

A good example was in 2000 at the top of the internet bubble. The knowledgeable, “insider” team made up of hedge funds, investment banks, other Wall St. operators and the private equity team sold bits of paper (shares) in exchange for money from the retail crowd.

Right now we are seeing another one of those times. But this time it is the “insider” team that is on a buying spree.

Commitment of Traders
I’ve already mentioned that the commercials were crazy long equity futures contracts and although some time has passed things have not changed. The commercials are long about $38 billion worth of contracts while the small speculators are long their smallest amount since the bottom of the bear market.

Fund flows
According to fund flows data estimates, as the retail investor is fleeing the equity markets and seeking the sanctuary of bond markets and money market funds, the institutional investor is buying with the same intensity. Watch video about half way on the link.

Insider Activity
Corporate executives and other insiders are probably the most knowledgeable about a company’s future and while the market has taken a tumble, they haven’t been spooked. On the contrary, their buying here is only equaled to that seen at the bottom of the bear market. This in contrast to the retail investor who has been buying anything but US equities.

Newsletter Market Timers
The best market timers among the newsletters are wildly bullish, with an equity allocation of 92%. Meanwhile the worst are out of the market completely with a 0% allocation.
Credit: Mark Hulbert in Barron’s