Trader’s Narrative

Apologies for the delay, I’ve been trying to keep up with this fakakta market. Here is this past week’s sentiment overview:

Sentiment Surveys
The AAII survey for this week showed only 33.33% being optimistic (bulls), and again, a whopping 55% thinking that the market is going to continue to go down. If you recall, historically, anything above 50% bearish sentiment is very significant. However, sentiment in a bear market is different than that in a bull market. So adjust your lenses accordingly.

The sentiment survey of Investor’s Intelligence by ChartCraft showed only 33.7% bulls and 47.2% bears (with the rest sitting on the fence).

Before we leave surveyland, it is important to note that something has truly scared the average American investor because not only are they very pessimistic as described above, they are now positioning their portfolios so defensively, it has only happened a few rare times. They are holding a +35% in cash, only 51% equities and the rest in bonds. The last time we saw a lower equity allocation for these guys was way back in the throes of the last bear market (late 2002) where it reached into the 40’s.

Options Continue to Confuse
On Friday, as the market continued to bleed, the ISEE sentiment ratio came in at 119, meaning that retail option traders were comfortably buying more calls to open positions than puts!

And the CBOE put call ratio (equity only) came in at an anemic 0.79!

So the options markets continue to confuse the heck out of everyone. I’ve read as much as I could find about it but either people are scrambling valiantly to explain it with outlandish theories or they are outright ignoring it.

The best alternative theory I’ve heard put forward is from Barron’s:

I mentioned sentiment being fearful earlier and certainly the Chicago Board Options Exchange volatility index, aka the VIX, registered some extremely high readings this week. Dubbed the “fear index,” when the VIX reaches extreme highs it often marks a bottom of some kind.
Finally, something for the bull column.
But can we truly believe the VIX, which is based on options premiums? After all, investors are no longer allowed to sell more than 1000 stocks short thanks to a temporary ban. One of the few places to hedge a portfolio is in the options market, and that may be changing the VIX in ways we just cannot know at this point.
Anecdotally, I don’t see the “get me out at any price” fear in the mainstream and financial media. Investors are fearful, but I don’t think they are truly as panicked as we might believe.
So, the scales seem to be tipped for the bears, keeping capital preservation tops on my list of investment activities. The final word from Washington could change things in a hurry, but from the technical evidence we have, this bear market is not over.

The What Spread?
This is truly scary. The TED spread continues to go up. The what spread? Yeah, that’s what a lot of people are wondering too. Take a look at the chart showing the trend of this search query in google’s search engine (worldwide). At the beginning of September, things go bonkers:

The reason I say scary is that it is creeping higher rather than spiking higher. That makes it difficult to know whether the trend has exhausted itself.

Magazine Covers
A qualitative contrarian sentiment guide is the magazine cover. Ideally, it will be tremendously pessimistic and have wide, general public circulation. This week, the only one fits the bill is the Time magazine cover of the 1929 soup line with the title: “The New Hard Times”.

The Economist and Forbes are arguably specialty magazines but their most recent editions’ covers are pessimistic as well. Although, the Forbes one does show the chart going up towards the end. And the article that corresponds with the cover, also hits some optimistic notes, mentioning the large amount of cash on the sidelines (more details on the cash cushion here). So, as pessimistic covers go, it doesn’t really qualify fully.

About a year ago I mentioned the powerful, contrary sentiment, punch that magazine covers pack. At the end of April 2006, the Economist did a glowing review of Goldman Sachs (GS) titled “On Top of the World”.

I wrote:

“…the recent Economist cover (above) should send shivers down the backs of anyone who is long Goldman Sachs…”

Here’s what happened to Goldman’s stock price from the time of the article to now:

With the exception of a short term blip that took GS to ~$165, the shares fell from $158/share to a low of $135.75. At best, GS was dead money for around 5 months.

The most recent company to be afflicted with the magazine cover curse was Akamai Technologies (AKAM):

Forbes featured Akamai in a glowing article in late April 2007 titled “Video Prophet”. You may think that the blame should rest squarely on Akamai’s disappointing fourth quarter earnings report but what, if not sentiment, is responsible for expectations being so high in the first place?

A recent Financial Analysts Journal article titled “Are Cover Stories Effective Contrarian Indicators?” by finance professors Tom Arnold, John H. Earl, Jr., and David S. North (from the University of Richmond, Virginia) argues that this sentiment signal shouldn’t be used to go long/short on negative/positive cover stories. Instead, their conclusion is the positive stories signal the end of outperformance for a stock, and negative stories signal the end of underperformance.

If I ever run a company, there will be standing policy to hang up on any and all media calls which may result in cover stories.