Trader’s Narrative

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.

Free Access to Elliott Wave International
Once in a blue moon, Elliott Wave opens up their subscription walls and for just a few days, you can download 120 pages chock full of the most recent trading ideas covering the US, European and Asian markets as well as interest rates, commodities, currencies and much more. This is the most recent edition of their comprehensive Global Market Perspective.

If you delay you’ll miss the chance because only during a brief window of opportunity are they giving you real-time access for FREE. There is no obligation to pay. No credit card needed, etc. All you have to do is sign-up with a valid email and in 10 seconds, you’ve got the same access as the regular paying clients of Elliott Wave and you’re downloading 120 pages of weekend reading. If you’ve got a pulse and you’re interested in trading, you can’t miss this opportunity.

Free Traders Magazine Subscription
Get a FREE subscription to Traders magazine. Take advantage of this offer right now because it will expire very soon.

Traders magazine informs the professional buy side and sell side trader about the evolving market structures. It covers trends on market making, globalization, block trading, technology, electronic trading, inter-dealer trading, soft dollars, electronic communications networks and all technology that impacts the trading community.

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)