Trader’s Narrative

The following is a run down of this past week’s sentiment data:

Sentiment Surveys
Let’s start by looking over some of the well known sentiment surveys:

The retail investors sentiment as measured by the AAII survey was equally balanced with bears and bulls both at 39% - and the rest undecided. To arrive at the tie, the bullish camp shrank by 9% points and the bears increased minimally (2% points).

ChartCraft’s Investors Intelligence continued to grow more bullish this week with 47.7% bulls and 23.3% bears (with the rest neutral). That’s more than twice as many bulls as bears! The last time we had this much optimism from this measure of newsletter editors’ sentiment was in December 2007. Interestingly enough, the S&P 500 back then was trying to get above its 200 day moving average - it didn’t succeed for too many days.

The Hulbert Stock Newsletter Sentiment Index (HSNSI) confirms the II data showing that the average equity exposure has increased by 60% points since early March 2009. Although some shift in sentiment is normal at the end of a bear market, this is double the average increase in the first 3 months of previous bull markets.

Rydex Ratio
We haven’t looked at the fast money traders in Rydex mutual funds. They have recovered from the March extremes but we are a ways yet from reaching the other side of the graph:

Option Traders

The CBOE put call ratio (equity only) fell to 0.55 on Thursday. That is a level which, while not being an extreme low, is low enough to show considerable confidence in the stock market. In effect, there were almost twice as many calls traded as puts (twice as many bets that the market would go up, as opposed to down). Other than this small blip, the larger picture hasn’t changed much since the last chart I featured in the sentiment overview last month.

The ISEE Sentiment data was even more lukewarm, offering no real clues from a contrarian perspective. The ISE equity only call put ratio was 191 which is relatively high. But we’ve seen a few isolated instances at this level before and it hasn’t been enough to stop prices from rising.

Hedge Funds
The latest data from Hedge Fund Research shows the average hedge fund 45% net long (as of May 19th 2009). That’s up from 33% earlier in the year but not as long as one year ago. The good news for the bulls is that there is still a lot of dry powder in hedge-land waiting to be deployed (especially if the market keeps going up and forces hedge fund traders to get off the fence). The bad news is that the so called ’smart money’ hasn’t really believed in this rally… yet.

Here is the summary of sentiment data for this past week:

Earnings Season
We are about to enter the heaviest weeks of earnings season, with some nasty surprises, so buckle up!

Sentiment Surveys
The weekly AAII sentiment survey reflects 36% as bears (a decline of -8% points from last week) and 44% bulls (a rise of 8% points). Not surprisingly, the rally is continuing to send positive ripples through retail traders.

ChartCraft’s Investors Intelligence survey of stock newsletter editors this week shows the most bullish posture since the start of this bear market (that is, assuming we’re still in it). With this week’s results, the optimists outnumber the pessimists for the the first time since January 2nd, 2009. Previous to that, it was in mid August 2008 and before that, a period of time from mid April to June 2008. All of those times coincide with market tops.

According to the Hulbert Stock Newsletter Sentiment Index (HSNSI), which measures sentiment among short-term market timing newsletter editors, while the market has spent the past 2 weeks treading water, newsletter editors are much more bullish. Two weeks ago they were suggesting to their readers an average long position of only 8.8% but now, that’s jumped almost 18% points to 26.5%. It isn’t the nominal value of the sentiment but the fact that there has been a remarkable increase in bullishness with no real market movement to provide a rational cause for it.

NFIB
It wasn’t that long ago when the National Federation of Independent Business (NFIB) Small Business Optimism Index fell to a new low. In April it once again set a record, falling to 81. Small businesses across America are continuing to retrench - no green shoots in sight!

Option Sentiment
Earlier in the week I outlined how the option traders are pushing their luck. Follow that link to get more details. During the rest of the week they continued to press their luck. The ISE sentiment index, tracking the retail options trader spent 3 consecutive days above 200 - meaning that they bought twice as many calls to open a trade as puts this week. The last time that we saw this many consecutive days of bullishness was in late December 2007 when the S&P 500 was trading at ~1475. The last time before that when the ISE sentiment index hovered over the 200 level for 3 or more consecutive days was in late October 2007 - when the market had just begun this brutal bear market. With odds like that, the rally is on very weak legs.

In confirmation, the CBOE put call ratio continues to hover around the mid-point (equity only data). This ratio ended the week at 0.56 - meaning that the option traders were buying almost twice as many calls to puts.

Fund Flows
Similar to the twitchy Rydex market timers, who are all of a sudden very bullish now, the typical US equity mutual fund buyer has finally returned to the market. Early fund flow data for the short term, weekly data, indicates that we are seeing tentative but clearly net positive inflows into US equity mutual funds. Of course, we can’t play a contrarian at all times. The stock market needs this capital injection - especially considering the gargantuan amount of scared money sitting on the sideline. But in the past, whenever these market participants have peeked out from under their covers and dared to re-enter the market, they’ve had their head handed to them. The most recent example was the new year top (January 2009).

NAAIM Survey
Although it slipped mention, the National Association of Active Investment Managers (NAAIM) sentiment survey was an emaciated 2.15 on March 4th, 2009, just days before the launch of this latest rally. Although I didn’t mention it at the time, I’m not sure if it is meaningful because in the short history of this sentiment indicator, there are two weeks with a more bearish outlook: July 9th, 2008 (2.03) and October 8th, 2008 (-2.97) and neither of them really resulted in much of a rally. In July, the S&P 500 went sideways and eventually wilted and in October the market thrashed about but quickly melted even lower. While I continue to monitor lesser known indicators like the AAIM, I’m not totally convinced that it has proven itself to deserve our full attention.

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Without further ado, here is the lay of the sentiment-land for this past week:

Investor’s Intelligence
According to this measure, stock market newsletters are on the whole equally split: 35.5% bullish and 36.3% bearish. This is the 4th week that we’re seeing approximately parity between the two camps. And since we are looking for extremes to point out inflection points, this is not helpful.

To learn about the origins of this sentiment survey, see A Brief History of Contrarian Analysis

AAII
The American Association of Individual Investors weekly survey came in with only 25% bulls and 44% bears. This is exactly the same percentage of optimists as last week’s AAII survey results.

More importantly, the allocation of money to stocks continues to be below 50%. If you recall, this metric hit an extreme low at the beginning of the year, falling to 42%. The last time we saw AAII respondents allocate so little equity in their portfolio was in late 2002 and beyond that right after the 1987 crash.

Rydex Nova/Ursa Ratio
A reader commented on last week’s sentiment overview that I should feature the Rydex Nova/Ursa ratio because it has given few and accurate signals. I’ve mentioned this sentiment metric before but as Wes said, the signals have been infrequent. The last time it appeared here was for the sentiment overview of November 7th, 2008.

As you can see on this chart, that was an extreme level and since, we haven’t seen anything remotely interesting from the Rydex Nova/Ursa Ratio:

To put that spike in sentiment in perspective, it was much lower than the pessimism that accompanied both the darkest days of the last bear market and the immediate after math of the tragic events of September 11th, 2001. So no doubt that what we saw was significant. But bear in mind that around the same time last year, almost every single needle was hugging the red line for dear life.

CBOE Put Call Ratio
The ‘traditional’ put call ratio measure fell to 0.71 on Friday and the equity only ratio reached 0.60 - that’s not so low to worry the bulls but if we continue to see a few more days like that next week, things would change.

ISE Sentiment
Once again, on Wednesday February 4th, the ISEE sentiment index fell below the magical 100 number (to reach 97). As was mentioned two weeks ago, this is something that has happened only a few times since January 1st 2008 - surprising, when you consider just how volatile and intense this bear market has been. With this weeks incidence, we now have only 9 occurrences where the call put ratio on the ISE has been below parity. As with the other times, the ratio quickly recovered above 100 to finish off the week at 132.

Hulbert Stock Market Newsletter Sentiment
Finally, returning once again to the newsletter editors, the subset of stock market timing newsletters followed by the Hulbert Digest shows that there are surprisingly few bears out there. The Hulbert Stock Newsletter Sentiment Index (HSNSI) finished the week at -7.4%; meaning that the average market timing editor out there is suggesting a small short position to their clients.

That might seem bearish but once you consider that the lowest it descended was -42.9% in July 2008 (not October nor November 2008!). And that just two weeks ago the HSNSI was -20% with the S&P 500 barely 60 points lower at that time, it is clear that this sentiment measure is not showing any type of capitulation or pessimism.

Magazine Cover
Energy shorts beware!
Business Week’s cover this week is a picture of Exxon as a ship’s hull with a leak. While most magazine covers are fodder for contrarian analysis, Business Week is a repeat offender so this is especially significant. Who knows, maybe it says more about Exxon’s stock price than the price of crude. But the two are more or less intertwined so I suspect if this has any contrarian value, it also applies to the commodity.

Also see:

• Sentiment Overview: September 2007 (Forbes, Fortune and Economist covers)
• When Magazine Cover Indicators Clash
• Magazine Cover Curse Strikes Akamai (AKAM)

Monday’s jarring market woke everyone up from the snooze fest we’ve had to endure recently. The 500+ point drop reminded those who were around then, of the 1987 crash. But of course, there was a world of difference between the two Mondays. Today’s bounce is, believe it or not, the normal thing for the market to do when it has undergone a large gap down.

Whites Of Their Eyes
Finally we saw some fear in the market as the CBOE Equity only put call ratio reached above 1.18 - that’s high but not near as high as it could potentially go. Today it pulled back once again below parity (at 0.93). But honestly, no one is convinced until they see this and other fear gauges spike into the blue yonder and higher, and then remain there for two, three or more days.

Lasting bottoms are carved out of pain and a total collapse of confidence. Although the news headlines are very pessimistic and one would almost be forgiven to jump into “contrarian” mode, the sentiment gauges don’t quite show the definitive panic that must precede an inflection point. For example, according to the Hulbert Newsletter Sentiment Index, the average newsletter editor is more bullish now than at the low in July. This, even though after Monday’s close the market was lower.

The volatility indices, VIX and VXN did spike higher but again, last summer and just a few months ago in January 2008, they got as high at 37.50 - so we are close, but still not high enough.

Devastating Breadth
Taking a quick look at the market internals, there were only 36 advancing issues on the NYSE and only 390 on the NASDAQ. The declining issues dwarfed them at 2,921 and 2549 for the NYSE and NASDAQ respectively. Trading volume was so lopsided that for each advancing share there was 172 declining shares. I haven’t done the calculation to see but it looks like a same assumption that Monday was a classic Lowry’s 90/90 day to the downside.

Technical Damage
There was serious technical damage all over the place. Not the least of which was, as mentioned before, the close below the July low. But what worries me, is that although there was damage done, it doesn’t show up as extreme on the charts as the screaming headlines would have you believe. For the most part the market is still approaching a final exhaustion. Where I would feel comfortable saying that there has been a washout of selling.

And yes, this is exactly the sort of thing that happens at the worst of times, when we are close to a major bottom. But I’m not convinced we are there yet. We are close, but before we get there we’ll see more volatility.

Take a look at the percentage of stocks trading above their 10 day moving average. Even after Monday’s decline, there were 17% above this short term moving average. For a lasting bottom, I’d like to see below 10% and preferably below 5%. Or take a look at the high low ratio:

Probably the most important thing to take away is that while heavy selling is a necessary part of an change in trend, by itself it doesn’t guarantee anything. But if heavy selling is followed closely by intense and almost indiscriminate buying, then chances are it is the real deal.

AAII
The retail investors as measured by the American Association of Individual Investor’s weekly sentiment survey are astonishingly pessimistic: 54% bearish.

To find a more gloomy view from the retail investor’s camp we’d have to go back to mid January when the AAII sentiment reached 59% bearish.

Back then I showed you this chart:

We have definitely seen 13 weeks pass since then and within a few more weeks will also complete 26 weeks. But unlike the historic average shown in the bar chart above, the market has yet to hold a decisive rally.

The S&P 500 Index (SPX) did momentarily reach a high of 1440 but couldn’t hold on to it. For most of the time we’ve been trading below the levels at which we first saw a +50% bearish AAII sentiment. As I’ve outlined before, sentiment during a bear market is a different beast.

Hulbert Newsletter Sentiment
Mark Hulbert is worried that while we may have put in a significant bottom with the March low, it may not hold. According to the Hulbert Stock Newsletter Sentiment Index (HSNSI) the average exposure recommended is a paltry 2.2%. And while this is low, back in early March the average newsletter editor was downright panicking with a -29.2% exposure - meaning actually being short the market with almost a third of total portfolio allocation.

As we head into a possible retest, it isn’t reassuring to see sentiment sitting so much above those levels. The ideal sentiment that would catapult us higher would be an even more intense panic with the kind of market weakness we’ve seen. While that may change anytime, the HSNSI doesn’t reflect that right now.

Investor’s Intelligence
No significant change in this sentiment measure: bullss dropped from 44.8% to 43% and bears increased slightly from 31.1% to 32.6%. It isn’t offering much of an edge as it sits in lukewarm waters similar to the Hulbert analysis.

CBOE Put Call Ratio
While the traditional put call ratio (equity only) did rise during the turmoil of this week, we didn’t see it reach or exceed the important 1.0 milestone. In fact, it only was able to muster a high of 0.84 on Wednesday. That reflects a good amount of fear but just not enough to carve out an important inflection point.

ISEE Sentiment
This past Wednesday and Thursday the ISEE Sentiment measure fell to 74 and 75 - the lowest since mid March low this measure reached 56 (March 10th 2008).

Remember, the ISEE sentiment numbers are calculated differently from the CBOE put call ratio. For one, the ratio is inverted with calls as the numerator and puts as the denominator. Further, the ISE only uses options which are traded by non-market makers, stripping out the noise and showing what retail and institutional traders are doing. And lastly, the ISE data is for opening orders only.

All in all, a much more robust and useful measure of options trading sentiment.

Rydex Traders
According to Jason Goepfert:

Rydex traders had finally started focusing on “safe” funds more than “risky” funds - a stark change from earlier in May when they were five times more likely to trade a risky fund than a safe one. As of yesterday, the ratio fell under 0.5, meaning that those folks were more than twice as likely to trade a safe fund than a risky one.

Conclusion
Since I eschew using a single indicator to light the way, the weight of the indicators are confusing with many cross currents pulling me in different directions. The troubling and somewhat muddy sentiment outlook doesn’t help. Hopefully things will resolve themselves soon and the picture will become clearer.