Trader’s Narrative

I have a nagging feeling this week will be one to remember. Whether it will be the bulls or the bears that will look on it fondly, only time knows. Here is this week’s unforgettable sentiment recap:

Sentiment Surveys
According to the Investor’s Intelligence survey of newsletter editors, we already had a dearth of bullishness, but now we have historically low numbers: 31.1% to be precise. Since stock newsletter editors are usually an upbeat lot, this is actually the lowest since October 2002 and early 1995.

Not to be outdone, the AAII survey of retail investors is showing that this week, 59% of respondents are bearish. We’ve been here before; at the beginning of the year. Lets see if this time we can light a flame under this rocket.

CBOE Put Call Ratio
Although the VIX rose moderately, thanks to the panic caused by the Bear Stearns (BSC) debacle, the CBOE (equity only) put call ratio zoomed above 1.16 - and I thought last week’s four year high was special!

Hulbert Stock Newsletter Sentiment Index
Mark Hulbert tracks newsletters in general but he also has a sentiment measure based on a sub-set of stock newsletters which time the market. This HSNSI is usually a fantastic contrarian indicator since editors tend to en masse, lose all hope when the market is carving out a bottom. And they tend to be euphoric when the market is about to have the rug pulled from under it.

Although this sentiment measure has been negative for some time, it is now showing real fear. This week it reached -22.5% which means that the average timer is recommending their clients short this market with more than a fifth of their money.

The really bullish significance of this is that in contrast to now, the last time the market was at these levels in mid January, the market timing newsletters were quite nonchalantly looking over the precipice. The fact that they have now soiled their pants (sentiment wise) provides us with a higher probability that the double bottom will hold.

To find a lower sentiment reading from the Hulbert newsletter sentiment index, we’d have to go back all the way to 2005. More specifically, to early May and mid October, 2005 when the market made two important lows:

“Dumb” vs. “Smart” Money
These are two proprietary indicators from Jason Goepfert that amalgamate several sentiment and technical indicators. The “Dumb Money” indicator fell on Friday to 12.5% which means that to find it a friend, we would have to travel all the way back to early 1995 and August 1998. You remember the summer of 1998, right? when we were suffering through the Asian currency and LTCM crisis? …good times, good times.

According to Jason, the gap between the two indicators is also as wide as it has been since 1995 and 1998. Pull up some long term charts and you’ll see the significance of that.

Consumer Sentiment
Although it would usually make big headlines, the results of the Reuters/University of Michigan Surveys of Consumers got buried amid the panic over Bear Stearns today. Consumer sentiment continued to decline to 70.5 - that’s the lowest reading in 16 years!

Like most sentiment measures, this one should also be taken with a spoonful of contrarianism: up is down, down is up. Which means that when consumers are most pessimistic, we have the best opportunity to go long. And when consumers are on average jumping for joy, we have to batten down the hatches.

News Headlines & Covers
Getting your umbrella out will do you no good. We have a torrential downpour of negative news and depressing headlines. To see what I mean, open any news website or newspaper. It is all doom and gloom. This or that hedge fund going belly-up, Bear Stearns pushing up the daisies, the mortgage market collapsing, the credit market in a spasms, consumer sentiment tunneling into the substrata, etc.

Even after the remarkable 90-90 up day we had on Tuesday, the majority are denying that it could potentially have any real bullish portent - although historical precedent says otherwise.

Here are a few recent covers from Business Week:

While everyone waited for the open of today’s market with bated breath, the word crash was thrown around like confetti. Retail investors crapped their pants (again). Here are a few frontpage stories from digg:

That’s notable because digg occupies itself usually with technology and science news. The stock market and the economy rarely make it to the front page. When they do, it is sensationalist headlines like those above… which makes for great a contrarian indicator.

With so much anticipation, the only prediction that came true was the Fed “surprise” rate cut that had been telegraphed weeks ago. The market certainly did not crash. It quickly recovered after the gap down from overnight trading.

Volatility
The volatility indices finally spiked higher: VIX reached a high of 37.57 and the VXN 40.77 - an almost 5 year high.

I was surprising to find that the number of Nasdaq stocks above their long term (200 day) moving average reached a low not seen since 2002:

This indicator is saying that the market’s internal breadth is as bad as it was in the final days of the bear market. I don’t know what to make of this since we only reached such horrendous levels after a brutal 3 year bear market.

Now, we are nowhere near that kind of market condition. Even so, here we are - as oversold as then.