Trader’s Narrative

The market correction that we’d been waiting for has finally started in earnest so let’s take a look at the sentiment data for this week:

AAII Survey
This week’s survey of US retail sentiment by the Association of American Individual Investors came in at 34% bullish (a drop of 7% points from last week) and an increase of bears to 42% (a 6% point increase). While the increased fear is normal after the kind of week we had, the ratio of the two remains neutral. Had the response been either muted or exaggerated, it would have been more interesting. At this point, it doesn’t really offer any edge.

Investors Intelligence
The latest Investors Intelligence poll from ChartCraft showed the bull share fall a smidgen to at 48.3%; the bear share also fell a hair to 22.5%. Only 29.2% believe a correction is due. The ratio of the bulls to bears is 2.15 - higher than it has been for months. It must be noted, though, that the survey was compiled on Tuesday before the losses later in the week. Next week’s survey will reflect the full decline.

Daily Sentiment Index
The Daily Sentiment Index remains in rarefied territory. The high levels we find the current DSI is extremely rare. In the 22 year history of this metric the DSI has been 87% or higher, only five times:

Continue reading ‘Sentiment Overview: Week Of October 30th, 2009′

Not surprising after the extremely negative sentiment in the US dollar index, the greenback has staged a modest rally. In response, gold has wilted. Here are few perspectives on what may be next for the precious metal:

Elliott Wave International
Arguing for the bearish case, is Robert Prechter of Elliott Wave International. He writes that since 1913, as shown in the chart below, the purchasing power of the US dollar has eroded by 96% (great job Fed!). If gold had simply offset this loss in purchasing power, it would have to have increased 25 times. But instead gold has multiplied in value by 50 times. Therefore, Prechter argues, it is 50% ‘overvalued’.

This is a strange sort of argument because most gold bugs would say that gold’s strength, the very fact that it has gone up so much, reflects positively on the precious metal. Prechter has had a very hot hand lately in timing the stock market so I’m willing to listen to his argument even if it sounds a bit odd. It appears that he implies that gold’s only sensible ‘value’ is to be the anti-dollar. However, I’m not sure that’s a valid point because as far as I’m concerned, gold is just another commodity with all the inherent susceptibilities to manias and panics we ascribe to other more traditional markets like stocks.

While I’m reticent to embrace this line of thinking, I do agree with something else that Prechter wrote recently about gold:
Continue reading ‘What’s Next For The Gold Bull?’

Here is this week’s sentiment round-up:

The AAII weekly sentiment survey shows that the consensus reversed suddenly from the giddily bullish extreme that we saw last week. The bulls fell to 37%, a decline of 17% points. And the bears increased to 40% coming to an almost perfect equilibrium.

While this is a dramatic decrease in their level of optimism, I’m still cautious. The last time we had the same level of bullishness in the AAII survey was in early May 2008. And as I mentioned during last week’s sentiment overview, the stock market didn’t roll over immediately in response. The S&P 500 actually climbed slightly higher in the following weeks. So just because the market has overtaken last week’s highs does not absolve it from a potentially mortal weakness.

The average exposure recommended by stock newsletter editors (as measured by the Hulbert Stock Newsletter Sentiment Index) fell to 30.3% - that’s a sharp decline of 17% points from just 7 days ago. From a contrarian point of view, if the level of bearishness continues to rise even as the stock market rises, then it would imply that this rally still has some life left in it. But we aren’t there yet.

This week’s Investors Intelligence survey was little changed from last week: the bulls were at 48.3% and the bears at 23.1%. This is the only sentiment survey that is dancing to its own tune.

According to the AAII asset allocation survey equity allocation has reached 57% - a level last seen before the equity markets started their cascade down last year.

We touched briefly on the bond allocation at the beginning of the month. At 25% (a 9% point jump!) it is not only the single largest increase but also brings bonds to the highest chunk of the AAII portfolio it has ever been since 1987 when they started keeping track.

Finally, to round off, retail investors are finally feeling comfortable enough to leave the safety of cash. After the cash portion of their model portfolio reached a peak of 45% earlier this year, it is now down to just 25%. As I’ve mentioned before, there is a massive pile of cash sitting on the sidelines and it is slowly being deployed. Of course not all of it is ending up in the equity market, but considering the size of the build-up, even a small portion can have a significant effect.

The NDR Crowd Sentiment Poll is a proprietary sentiment measure from Ned Davis Research. It surpassed its extreme level (61.5) last week. Since then however it has backed off from this threshold and is now 4.3 points lower to 59.1 - this is similar to the other sentiment surveys covered above.

Fund Manager Survey
According to a Merrill Lynch survey of 204 fund managers, managing a total of $554 billion, 75% believe that the global economy will improve in the next 12 months. That is the highest level of optimism since November 2003. A smaller amount (70%) expect corporate profits to rise in the coming year.

Fund managers are putting money where their mouth. They have reduced their cash levels from an average of 4.7% in July to 3.5% in August - the lowest level since July 2007. They have also increased their allocation to equities sharply from last month. Merrill Lynch’s Risk and Liquidity Indicator, which measures risk appetites is at a 2 year high.

This dovetails nicely with what we are seeing from the AAII model portfolio allocation (above). The build up of cash was a sudden, fear induced spike. But the unwinding of it is more orderly as a gradual stream of investors decide that it is safe to venture out once more and take risks again.

Option Traders
The CBOE (equity only) put call ratio continues to fall as optimistic traders prefer calls to puts. Friday it closed at 0.51 meaning that traders were trading twice as many calls as puts. The simple 20 day average of this ratio is now at 0.587 - the lowest since June 2007:

Perhaps more importantly, the short term moving average has as a result, broken well below the multi-year rising channel that contained the put call ratio (red arrow).

The lesser known ISE sentiment index (equity only) reached a high of 202 on Friday. Being a call put ratio, this means that for every 100 puts, there were 202 calls being bought. But the short term moving average of this indicator is still treading water and not at an extreme.

Magazine Cover Indicator
Here is the August cover for Futures - a magazine dedicated to news and analysis of options, futures and stock trading. It is not a general interest magazine like Newsweek or even Business Week so I’m not sure how much contrarian weight we can put on it.

In any case, the image is of a hazy outline of a bull appearing in the distance. The implied question is, “It might be, it could be, is it?” meaning a bull market. Obviously this is the question that many are grappling with.

The interesting aspect of this cover is that it is not boldly trumpeting the arrival of a new bull market but instead timidly asking if it might be, could be true. And finally, wondering if it truly is.

By the way, if you have a US mailing address, for a limited time you can get a free subscription to Futures Magazine. I’m not sure how long this special offer will last so sign up right now.

Consumer Confidence
The preliminary Consumer Confidence survey from Reuters/University of Michigan showed a surprising decline to 63.2 for August - back to a level not seen since March 2009 when the market hit its trough. It would seem that the US consumer is being buffeted with the cross winds of deflation, which make things more affordable, rising unemployment and a schizophrenic stock market. No wonder then that they can’t seem to make up their mind:

Here is a quick wrap up of this past week’s sentiment data:

Sentiment Surveys
The American Association of Individual Investor’s (AAII) weekly sentiment survey had 38% bulls this week and 42% bears. That’s an increase in the ratio of optimists and a decrease in the proportion of pessimists. But all in all, we’re back to where we’ve been for the past few months - basically back and forth without hitting any noteworthy extremes.

According to the Investors Intelligence survey of stock newsletter editors, we had 36.7% bulls and 35.6% bears. That’s almost absolutely unchanged from last week. So once again, not much is changing in people’s perception of future stock market returns. And the results have the field split almost equally down the middle.

The Hulbert Stock Newsletter Sentiment Index which also measures stock newsletters who attempt to time the stock market is showing a surge in optimism. Among the group of market timers, the average recommended exposure to the market is +46.5% - this means that they are telling their clients to put 46.5% of their assets in the market (on the long side). The last time they were this optimistic was back at the start of the year - when, as coincidence would have it, the Dow Jones was also trading above 9000 as it is once again today. But I’m not convinced that this is a negative omen for the market since the level of bullishness is not extreme at all.

Options Sentiment
The CBOE put call ratio (equity only) actually increased along with the S&P 500 index. On Monday the put call ratio was 0.59 - suggesting that calls were almost twice as sought after as puts. By today the ratio had risen to 0.78 while the S&P 500 rose 28.13 points for the week. This parallel up move is a rare occurrence between the two indexes and it suggests that at least when it comes to the options market, there isn’t a euphoric acceptance of the rally’s longevity.

The ISEE sentiment index is also confirming the same nonchalant mood in the options market. Here is the updated chart showing the daily and 10 day moving average for the equity only ISE index:

If you look closely at the far right edge, you can see that the short term moving average has flat lined. Remember that the ISE is a call put ratio so the higher the number, the more optimism and the lower the ratio, the more fear it reflects.

Here is this week’s sentiment summary:

Sentiment Surveys
Figures from ChartCraft’s Investors Intelligence show stock newsletter editors to be similarly bullish to last week: 43.6% bullish and 28.7% bearish. Not only is this little changed from last week, it leaves us mired in a neutral morass which is not really helpful in determining a trend.

In contrast, the weekly AAII data is a bit more attention grabbing. As measured by the American Association of Individual Investors, the percentage of US retail investors who are bearish increased by 3% points to 49% and those who are bullish declined by 5% points to just 28%.

As you might recall, we saw a record setting AAII bearishness that coincided with the start of the spring rally. This week’s sentiment figures are the most pessimistic since then. While some would interpret this as bullish for the market, it may not be that simple.

While sentiment is helpful in pointing out inflection points at extremes, the rest of the time as it meanders it is either not really helpful at all. If you really want to analyze it, sentiment tends to go along with the trend in the market until it tips into a severely lopsided situation. So in fact, while we are not seeing extremes, sentiment can be seen as a guide to confirm a trend, rather than as a contrarian indicator. This is a distinction that makes sentiment much harder to analyze than merely zigging when it zags.

Therefore, since the AAII data isn’t at an extreme level of bearishness, we can’t really use it as a contrarian measure. All we can say is that fewer people are bullish, which means that less and less are feeling like putting money to work. That isn’t necessarily great news if you’re bullish.

Finally, the Hulbert Stock Newsletter Sentiment Index which is another measure of stock newsletter editor’s stance has fallen from 45.8% early in June 2009 to just 15.8% in recent days. Such a retreat confirms what we are seeing in the other sentiment data (above); bullishness is fading to varying degrees but it is not yet at a point of extreme. Mark Hulbert, the creator and keeper of this sentiment indicator, believes that such a move has contrarian portent because while sentiment has fallen to levels last seen in early April, the market is much higher.

Options Sentiment
The CBOE put call ratio’s short term moving average is climbing higher after reaching a low in mid May 2009:

Keep in mind that the put call ratio has a slight upward bias so if you draw a line you can see the connection between the July and October 2007 put call ratio lows - which coincide with the bear market top. While this measure of sentiment has increased in recent weeks, it is a long ways off reaching previous highs of 0.85+.

Below is an updated chart of the ISEE Sentiment Index (equity only) which I showed about a month ago:

Similar to the CBOE put call ratio, we’ve seen a decrease in bullishness (notice that the ISE is inverted because it is a call put ratio). Since early June 2009, the 10 day moving average has come almost straight down from 181 to 152. But as you can see, it is far from an extreme low. On November 24th, 2008 the 10 day moving average of the equity only ISE call put ratio was 108 and on March 24th, 2008 it was 104.

I’d caution you to take all options analysis with a salt lick. Both the CBOE and ISE data has not conformed to historical ‘norms’ of sentiment analysis during this bear market. For example, notice that neither recognized the March 2009 lows.

Volatility
The CBOE volatility index (VIX) continued its slow, meandering crawl downwards this week. It closed a hair’s breadth below 26, which is the lowest it has been since September 15th 2008. The VIX has fallen off many radars because during this bear market it reached unheard of levels and as a result, what was once considered extreme is now the new ‘normal’. I suspect that it will be a long time until we can put this whole episode behind us and take a look at the VIX the way we used to before.