Trader’s Narrative

Here is this week’s sentiment summary, bursting at the seams with sentimental goodness:

Sentiment Surveys
According to this week’s AAII sentiment survey, the US retail investor is becoming outright bold. The bullish crowd surged to 50% while the bears increased slightly (4% points) to 35%.

ChartCraft’s measure of the average investment newsletter editor’s sentiment - Investors Intelligence - also showed a similar level of optimism: the bulls increased 5% points to 47.2% while the bears fell 5.3% points to just 25.8%.

Rounding out the trifecta near or at 50% was Market Vane (US equities) at 46% bullish. That’s the most bullish it has been since May 2008 when the S&P 500 was trading at 1400.

Ned Davis Research’s proprietary sentiment indicator, called the Crowd Sentiment Poll stands at 62% - just eking into the extreme optimism range (anything above 61.5%). In the past this measure has reached highs of 68% which would give the sign for investors to sell weaker holdings.

Finally, Jake Bernstein’s proprietary sentiment indicator, Daily Sentiment Index (DSI) is also showing an extreme level of bulls. For the Standard & Poor’s 500 index the sentiment reached a high of 88% bullishness. The Nasdaq 100 sentiment was marginally lower at 87%. Needless to say, this is indicative of a short term top.

The DSI is uncommon, especially outside professional settings. Partly this is because Bernstein keeps the method and calculation a secret but also because it is an extremely expensive report. But what I’ve heard from trading friends, it is well worth it as it has just about nailed the exact inflection points at every major move.

Fund Flows
In last week’s sentiment overview we briefly touched on the gargantuan amounts of cash sitting on the sidelines of the market. While we’re now seeing flows out of cash only a small fraction is going to equities.

In fact, it would be accurate to say that the powerful spring rally has been mostly driven by institutional traders and investors with very little juice coming from the retail ‘Mom and Pop’ investor. According to the Investment Company Institute (ICI) small investors have only poured in $4.1 billion into the equity markets (for July). That’s chump change, especially when we compare it to the flows from cash to bond funds which stands at $28.8 billion. More on the bond market below.
Continue reading ‘Sentiment Overview: Week Of August 7th, 2009′

Since I got my hands on my copy of Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy, I’ve been devouring it almost non-stop.

Written by Barry Ritholtz, Director of Equity Research at Fusion IQ, and blogger at The Big Picture, it promised to be a definitive guide to the financial mess - and it didn’t disappoint.

In his inimitable colloquial tone Ritholtz sets out to meticulously explain how the stage was set for the historic unraveling of the global economy in 2008. Although we will no doubt have a plethora of similar books, Ritholtz’s book, for its detailed historical approach and its comprehensiveness will probably end up being the encyclopaedia that future historians and traders come back to.

Filled with charts, diagrams, cartoons and highlighted sections, Bailout Nation grabs hold of your attention and never lets you come up for air until the very end. I found very few errors or bumps along the way. Some sections were a bit repetitive. For example, referring to the case of LTCM, he says:

The collapse of that hedge fund in 1998 and its subsequent Fed-orchestrated rescue plan provided one of the greatest — and most terrible — examples of moral hazard ever known.

Then a few paragraphs later:

Contrary to what Greenspan claimed, the Federal Reserve’s involvement did not create “slight” moral hazard. Rather, the 1998 Fed-orchestrated rescue was moral hazard writ humongous.

Yes, we get it Barry! But because the book is so well written and researched, I’m nitpicking here really.

I truly appreciate that Ritholtz comes across as politically agnostic. He excoriates both the Democrats and the Republicans for reckless policies and decisions that have no logic but foster a culture of entitlement, reduce or entirely eliminate regulation and get private enterprises addicted to public funds.

Most Americans are labouring under the patriotic delusion that they live in a free market society. But for all their pro-capitalistic bravado, America’s history is replete with corporate welfare. Both Democratic and Republican governments have lavished public funds on businesses that would have gone extinct in a real free market. To start at the beginning, Ritholtz highlights the precedent setting bailout of Lockheed Martin in 1971. This was the first time the US government had acted to help out a single corporation. He then proceeds to describe the other bailouts, which by now had become the norm.

Ritholtz spies a 10 step pattern of bailouts:

1. Risk Event
2. Pre-awareness
3. First Reactions
4. Bigger Reactions
5. “Interested Party” Agitation
6. Official Concern
7. Broader Worry, Deepening Panic
8. Major Intervention/Bailout
9. Rationalization & Apologies
10. Expected Results and Unintended Consequences

It isn’t too hard to spot us at stage 9 - with Greenspan’s sheepish “flaw” apology and Geithner’s haphazard attempts to sell everyone on his ill thought out PPIP proposal.

When it comes to casting blame, Ritholtz doesn’t pull any punches. As you can imagine, with a foreword written by Bill Fleckenstein (author of Greenspan’s Bubbles), Ritholtz doesn’t shy away from criticizing the Maestro. In fact, he puts him front and center, as the primary enabler of this convoluted tragedy. But he also defends what he considers to be “misplaced fault” such as naked shorting, mortgage interest deduction, etc. I don’t totally agree with him on naked short selling. The deregulation that he cites elsewhere was also why naked shorting was allowed to take place - at times on a massive scale, with devastating consequences.

Ritholtz also cites a very clever reason for why Wall St. got greedy in the first place and went into overdrive, taking on fatal amounts of risk. I won’t ruin the aha! moment for you but it is signature Ritholtz to be able to pull together very disparate variables and see a pattern emerge.

I’m often asked by friends and family members to explain why Wall Street just imploded. Bailout Nation is an accessible and fun to read book that explains every question they have - and a few they never even thought of asking.

The sideshow to the dead cat bounce (more like a rocket ride) was the brewing TV feud between The Daily Show and CNBC. If you missed the final show down, check out the link to watch the complete, unedited version. While Stewart rightfully gutted Cramer like a fish, what I wish Stewart had mentioned explicitly is that if you give a platform for analysts, CEOs, etc. to spout off, then you also have the responsibility to fact check, ask tough questions, research, etc. You know, journalism. It is a sign of our upside down world that a comedian is playing the role of a serious journalist while a former hedge fund manager is playing a clown.

That and more, in this week’s reading list at news.tradersnarrative.com:

• Jon Stewart’s secret Wall St. insider connection
• Suppress the Urge to Call the Bottom
• Parabolic Move in Financial Sector
• One Last Bubble Remains to be Popped
• Bear Market Rally… or Real, Lasting Reversal?
• Stocks That Aren’t Coming Back
• Ignoring the Austrians Got Us in This Mess
• Greenspan Tries to Re-write Monetary History
• How Wall St. Bought the Govt & Cut Regulation at the Knees

And remember to check regularly since there are links added regularly throughout the week.

Former Federal Reserve head honcho Alan Greenspan said today that he was “shocked” at the breakdown of the financial order.

Those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity — myself especially — are in a state of shocked disbelief.

Shocked, SHOCKED! I tell ya! … which inevitably gave me this flashback from Casablanca:

Greenspan was putting in a performance for the House of Representatives Committee on Oversight and Government Reform. He was badgered into giving a lukewarm mea culpa, saying that maybe, sorta, he was, you know, “partially” wrong about blocking any and all attempts at regulation.

It is quite simple really. And it should be even clear to the politicians sitting in front of Greenspan by now. He flooded the world with too much liquidity as an attempt to save the US from the consequences of the tech bubble imploding. He created the carry trade, the “Greenspan put” and will undoubtedly do down in history as the worst Fed chairman in history.

Well, to be charitable to Alan, as a Fed chairperson, I think he was a very good politician.

Since I’ve been harping on about the gap between the Fed Funds rate and the 3 month Treasury Bill rate for almost a year now, I thought that it would be fun take a really long term look at their relationship.

Here is a chart of the difference between them going back more than 18 years:

There are several things that jump out from this cursory analysis:

• what we just went through was extraordinary
• spikes tend to correspond to stock market turmoil or bottoms but not always
• over the time covered, the average gap is 29 basis points
• under Bernanke, the gap has been larger & more protracted than Greenspan
• rarely does the 3 month T-Bill rate go lower than the Fed rate
• Fed responded very quickly to financial shock of 9/11

Since I’m lazy I used the historical data readily available from Yahoo! Finance but I’d appreciate someone with access to cleaner data from Bloomberg or Thompson to corroborate the results.

The most important thing to take away from this is that there definitely is a relationship between these two financial instruments. Their long term average difference is so small: 28.9 basis points. And they tend to follow each other around most of the time. This isn’t surprising though since just a glance at the two charts side by side going back to the 1940’s shows their relationship.

This indicator may be useful as a tool to gauge financial shocks, and by corollary, buying opportunities. But since the attitude and responsiveness of the Federal Reserve chairman in power can influence how fast they respond to the market rate, it isn’t that objective.

At best it is just a starting point for further study. If you play around with it and find something interesting, drop me a comment to update me.