Trader’s Narrative

Since we are considering whether this is a potential top, I thought a closer look at the ISE Sentiment data would be helpful. This is the options transactions on the ISE and it is predominately retail traders so it can help us to zero in on the more novice participants. Since the ETF and index options can skew things, I discarded them and only included the equity only data. Then I also charted a simple 10 day moving average to smooth out the daily volatility.

I featured a similar chart the Sentiment Overview for mid May but it didn’t have as much data as this one. We are getting up there, but not as high as before. The 10 day moving average of the ISEE Sentiment Index is 181. That’s the highest since January 2nd 2008 when it reached 186.9.

Also notice that the March 2009 stock market low doesn’t even register as a blip on the 10 day moving average.

I also looked at the ISE equity only data and focused on any 250 and above - meaning that for every 100 puts, 250 or more calls were bought on that day. Then I looked what the S&P 500’s return was going forward from that day for 1 month, 3 month and 6 month intervals. Here are the results:

There is a definite negative bias, but it isn’t overwhelming. If anything, the market is flat to mildly negative. But we haven’t seen such a wildly optimistic day in a long time. The last time was on October 29th, 2007. Also, notice that the 6 month negative returns start to pile up from June 2007 and onwards. Before that, things are basically flat.

To see the flip side (extreme lows) check out ISE Sentiment: A Closer Look - but note that the data for this includes all securities (equities, ETFs and indexes).

Yesterday, while meeting with Gordon Brown, President Obama said:

What you’re now seeing is profit and earning ratios are starting to get to the point where buying stocks is a potentially good deal, if you’ve got a long-term perspective on it

While cheerleading the US economy and stock market is part and parcel of being the president, that his is a fairly accurate description:

Source: Prof. Robert J. Shiller

And while some are pointing out a dichotomy between Obama’s pronouncement and his advisor Buffett’s description of the US economy as being in “shambles”, there really isn’t a conflict with the two views as long as you realize that the economy and the US market are two different things.

In any case, the data for February and March 2009 are an estimate only and take us down to 12 - which is without an argument a very low P/E Ratio. But not as low as we’ve seen the price earnings ratio go.

In August 1982, the PE Ratio dropped below 7. And in both July 1932 and July 1921 it went below 6. To see that scenario again, the S&P 500 would have to drop another 40-50% to the 430-360 level (assuming earnings miraculously stay the same).

The only time that the PE Ratio has dropped as precipitously as in this bear market was in the aftermath of the 1929 bull market top. At its zenith in 1929, the PE Ratio was only approaching 33 while in the 2000 market top it reached 44.

Finally, I should mention that this isn’t necessarily the way that others calculate PR ratios - Shiller methodology smoothes out the data over 10 years to remove short term volatility.