Trader’s Narrative

This week’s sentiment run-down has a lot of cross currents so be careful:

AAII
After last week’s sudden stampede to an extremely gloomy stance, the weekly survey of retail investors by the American Association of Individual Investors is showing a dramatic realignment to perfectly neutral. The bears and bulls both stand at 39% after a -/+17% percentage point change.

Investors Intelligence
The percentage of stock market newsletter editors who are bullish on the market fell to 44.4% from 48.3%, while bearish sentiment rose 2% points to 26.7%. This is a slight decrease in the ratio of bulls to bears, since we’ve been so accustomed to seeing it at 2:1.

To thoroughly confuse those with any leftover conviction, according to Consensus bulls on the stock market are at 74% - a previous high not seen since October 2007. Similarly, 78% are bullish on gold.

Daily Sentiment Indicator
The Daily Sentiment Indicator, calculated by Jake Bernstein, is showing an elevated level of optimism. The 10 day moving average of the DSI is at 70%, having fallen from the recent peak of 75%:

Consumer Confidence
The preliminary Reuters/University of Michigan Consumer Confidence index fell to a 3 month low of 66 (from 70.6 in October). Most analysts and economists expected a small increase in confidence. While it was unexpected, it shouldn’t be that surprising since the media has been filled with reports of the unemployment rate hitting the psychologically important 10% level. And as this is a preliminary number, it could be revised later.

The German ZEW Index
Looking across the pond, the most popular measure of German economic confidence, the ZEW index dropped to 51.1 in November from 56.0. The consensus was expecting 55.0. Meanwhile, the current situation index increased 2 points to -72.2 - with expectations being a rise to -69.

Mutual Fund Cash Positions
Standing on the “shoulder of giants” (aka Jason Goepfert), we looked at the level of cash being held by US equity mutual funds back in September. While being a ’sloppy’ market timing tool, its message was decidedly foreboding. And with the passage of some time, it has become more so as mutual fund managers are holding even less cash:

Corporate Insiders
According to Vickers Insider Report, corporate insiders have sharply curtailed their selling. Current buy/sell activity is 1:1.96 - that is on average, insiders are selling 2 shares for each they buy. Since compensation of corporate executives includes a healthy dollop of shares, it is natural for their activity to be skewed. However, since the long term average of the buy/sell ratio is closer to 1:6.5, the current level is rather bullish.

Google Investing Index
Google (GOOD) is a great source for sentiment on the stock market. Google Trends is where the search trends around the world are categorized allowing us a window into the public’s mood. For example, how much people search for “stock market crash” or “buy gold”.

Another metric is the Google Investing Index (GII) which tracks an amalgam of keywords related to investing such as “stock, finance, stocks” and so on. The peak of searches for these keywords was late last year on October 10th 2008 when there was an 86% increase in year over year activity:

Source: Google Finance

The opposite happened just recently in mid October 2009 when there was a decrease of 52% in people’s interest in all things related to investing. At least according to this specific measure. If capitulation is defined by total disinterest and apathy then based on the GII, we’ve arrived. This nicely dovetails with the complete withdrawal of US retail mutual fund investors.

Greybeards
Every once in a while I like to check in with a market ‘greybeard’ - my name for someone who has been around enough to see several cycles and has made more correct calls than not. This week, we review Albert Edwards at Societe Generale. He is an avowed bear who completely dismisses any talk of a recovery or bull market.

In a recent research note he flagellates himself for not having seen the ensuing rally off the spring lows:

To be perfectly honest, as the market powered ahead, I, like so many others, waited for the pull-back that never arrived. Do I feel like a grade 1 moron? Yes, I most sincerely do. Should I be beaten mercilessly to within an inch of my miserable life? Definitely.But I remain convinced we are still in a structural bear market and that this economic recovery rests on such shallow foundations that it will be washed away by the first moderate wave.

Always the grump, Edwards expects China to go into a recession, expects a similar fate for the US in 2010 with new lows for the stock market and a deflationary panic is in our future. You can find a recent report from him in the Free Trading Resource (Reports & Articles).

This week the sentiment data brings a very intriguing turn of events so let’s get started:

Sentiment Surveys
The star this week is the ever so humble and common AAII weekly survey of US retail investors. This sentiment indicator sends extreme signals every once in a blue moon. So I guess you better check the night sky tonight because we haven’t seen so few bulls in this survey in a long time.

This week’s AAII results show only 22% bulls and a whopping 56% bears. The last time we saw this few optimists and this many pessimists was the week of February 19th 2009. Just before the spring rally. To put that in (even more) perspective, out of all the data that we have so far, only 4% of the time have there been less bulls.

Here is a chart of the bull ratio (bulls divided by the total number of bulls & bears):

I’ve zoomed in to the past 7 years or so since showing the whole time series from 1987 would be overkill. From 2002 till now, there have been 8 instances where the AAII bull ratio was less than 30%. But as the last extreme reading in February suggests, it is best to not act in haste when presented with such a scrumptious contrarian gift. Historical data suggests that sitting on your hands for the next few weeks is the most prudent strategy (for longs).

I hope that I haven’t understated the gravity of this week’s AAII sentiment survey result because there is a high probability that it will once again prove to be prescient in pinpointing an upcoming inflection point. It is most definitely a tell that after a 55% rally we find the AAII bull ratio at such an extreme low when in early 2004 after a 37% rally from the 2003 lows the bull ratio was at the other extreme (see above chart).

The one puzzling thing is that the AAII asset allocation survey shows a slight uptick in equities (to 57%) while back in February when the bull ratio was so low last, it was closer to 40%. I guess the message the AAII folks are sending is that they like equities longer term but short term they’re very nervous. And that’s remarkable because of how little off we are from the year’s highs.

Investors Intelligence
While this week the AAII deservedly monopolized our attention, the measure of newsletter sentiment from ChartCraft is a snoozefest. The II this week is almost completely unchanged with 48.3% bears and 24.7% bears for a (yet again) bear to bull ratio of 2:1. I’m not sure how to reconcile these two disparate metrics but I do know that this is really nothing new as they often conflict with one another.

Hulbert Newsletter Sentiment
Thankfully, we have another measure of newsletter sentiment. Currently, the Hulbert Stock Newsletter Sentiment Index (HSNSI) stands at 3.2% - which implies that the average recommended exposure by short term timing newsletters is to be long 3.2% of their client’s portfolio.
Continue reading ‘Sentiment Overview: Week Of November 6th, 2009′

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′

It is the end of the week and so we take a stroll through the sentiment meadows:

Investors Intelligence
This week the ChartCraft measure of stock newsletter editors sentiment was little changed from last week: 49.5% bullish and 23.1% bearish. That’s another week where twice as many are optimistic that the stock market will continue to rise. A remarkable long string of weeks but so far they have been correct.

AAII
The US retail investors meanwhile, as measured by the weekly AAII sentiment poll are slightly less confident. There was a 6% point fall to 41% bullish. And the opposing camp increased a smidgen to 36% bearish. All in all, this metric is slightly elevated towards too much optimism but still not enough to warrant our full attention.

Hulbert Stock Newsletter Sentiment
The Hulbert Stock Newsletter Sentiment Index (HSNSI) which measures a subset of newsletters which try to time the market continues to be muted. For the most part the HSNSI is showing skepticism in the face of the continuing rally. The HSNSI is about as bullish as it was back in April 2009 when the S&P 500 was trading at 800 - some 280 points lower. That is to say the average market exposure recommended by market timing newsletter is only 32.3% (long) - slightly lower (by 2.3% points) than what they were recommending 6 months ago. Such an unflappably consistent skepticism in the face of a gravity defying rally hardly gives the bears much ammunition.

Consumer Sentiment
The preliminary October results for the Reuters/University of Michigan consumer sentiment index fell to 69.4 (significantly lower than the consensus estimate at 73.4):

During economic contractions, the average Michigan consumer sentiment is 74. The average during economic expansions is 91. And on average when the S&P 500 has rallied 60% from a recessionary low, this consumer sentiment reading is 90.5. These historical patterns offer a remarkable contrast to where we are today - especially if we consider the often repeated mantra that we are in full blown recovery mode.

Option Traders
The 10 day simple average of the ISE sentiment index (equity only) call put ratio has an enviable track record - in the intermediate time frame. Almost every time it has reached 200, the stock market has meandered then stumbled. Not at all surprising since this implies that for the past 10 trading days, relative to puts, more than twice the number of calls have been purchased to open an options trade. Not once has the stock market been able to muster a significant rally when we’ve seen this metric reach such an extreme reading.

So it is important to sit up and take notice as this week the 10 day average for the equity only call put ratio floated up to 200 and on Thursday hit 202. During the relative short history for this sentiment metric, here are the few times where it has been above this mark:

The first was at the start of 2006 - the S&P 500 plateaued then fell into the summer. It wasn’t until September 2006 that it had reached a new high for the year.

The next instance was late in 2006. This was not the best signal since the market did manage to continue to climb momentarily. By March 2007 the S&P 500 was back at the same level.

Then it was May and October 2007 when the ISE’s 10 day average again touched 200. During that time frame the market did manage to push against the tide but over all it went nowhere. And we all know what happened after that.

CBOE Put Call Ratio
In contrast, the CBOE put call ratio (equity only) has recovered smartly from the call buying frenzy that we witnessed last week. Although we’re seeing the bulls reign in some of their enthusiasm for calls, it is important to note that from a long term perspective, we are still seeing a preponderance of hope and optimism rule the option pits:

Fund Flows
Last month we looked at the remarkable trend in fund flows for US retail mutual fund investors where even after a 60% rally in the S&P 500, the love affair with bonds continues at the expense of equity mutual funds.

Since then the same trend has more or less continued. Bond funds are still getting the majority of investors money but this week the ICI estimates they only got $8.80 billion (while last week it was almost double that at inflows of $15.21 billion). Equity outflows meanwhile have ameliorated with an estimated $3.39 billion being withdrawn for the week. This is down by about $1 billion from last week.

While a portion of this trend can be explained by the massive number of retail investors who are approaching retirement age, I can’t believe that that is the whole story. This bear market left a traumatic and indelible mark on those who lived through it, either as traders, investors, professionals or mere mortals. If this is true, then going forward, this means that we have to be very careful in how we calibrate our most trusted sentiment gauges.

Here is the sentiment wrap-up for a week that saw new yearly highs:

Dow 10,000
Yes, the Dow Jones reached and surpassed the magically round number 10,000. But in case you were too busy to count, this is for the 26th time it has done so in the past 10 years. So that means we’ve had about 10 years of zero returns (excluding dividends and inflation). Those specialty party hats the NYSE hands out are well worn by now and no one really knows what we’re supposed to be celebrating.

Sentiment Surveys
Turning out attention to the AAII weekly sentiment survey, we find a large jump in optimism among retail US investors. This week 47% are bullish - a jump of 12% points from last week. In contrast there are 34% bears (a drop of 7% points). Usually this survey gets my attention anytime a particular camp has majority. We’re not there yet, but this is mighty close.

While you will most likely interpret this lopsided survey result to be contrarian bearish, keep in mind that the previous time we saw the bullish ratio this high was a few months ago in July 2009. As the chart shows, the S&P 500 index shrugged off any suggestions of ‘too much optimism’ and barreled ahead gaining 150 points. If I were relying on just the AAII survey, ideally I’d like to wait for the bulls to get to 50% or more before being confident about it tripping up the market.

Investors Intelligence
While the AAII bulls took the reins this week, the weekly survey from ChartCraft measuring the stock newsletter editors sentiment has been dominated by the bulls for a few months now. This week was no exception as the Investors Intelligence indicator came in with 47.2% bulls and only 26.4% bears. So this isn’t all that helpful because while II has been stuck showing about twice as many bulls as bears, the market has continued to rise.

National Federation of Independent Business
The monthly NFIB survey results show September inched ahead at 88.8 - which is pretty unimpressive since it isn’t even higher than the results in May (88.9). As well, 6 of the 10 sub-components were either down or flat suggesting that the tiny improvement came from a narrow contribution.

The details of the NFIB survey show the huge disconnect between Wall St. which has enjoyed a 60% rally and an attitude of ‘back to business as usual’ (with bigger than ever bonuses) and Main St. which is still struggling with a very weak economy. Small US businesses are not ready to build up inventories, nor are they planning on expanding capex spending, nor are they hiring, nor are they expecting credit conditions to ease. Small business in America is referred to as the engine of the economy but it has been neglected while ‘too big to fail’ banks and investment houses become even bigger and received billions of dollars from the government.

Option Traders
The sentiment in the option pits continues to be very very bullish. While some of the penchant for calls can be attributed to the stock replacement strategy, I don’t think that explains enough to discount the alarming extent of the skew.

The ISE sentiment index (equity only) which exclusively measures retail option traders opening transactions spent 4 days out of the 5 trading days in this past week above 200. That was enough to take the 10 day moving average of the equity only call put ratio to 200.8 which is the highest since November 2007. For a chart, see the sentiment overview at the start of the month.

The CBOE (equity only) put call ratio is also showing a similar pattern of excessive call buying. Its 10 day simple moving average is 0.52 which is among the lowest levels for many years. In the following chart, you can see how the S&P 500 has responded when we’ve seen this much optimism:

This is by no means an exhaustive or quantitative study but it does show that while the equity markets can rise a bit in the face of such bullish option sentiment, sooner or later, it catches up with it. Either the market goes sideways or corrects sharply. Hmm… that sounds familiar.

Volatility
As an alert reader pointed out, the CBOE volatility index (VIX) is now scraping a bottom not seen since September 2008. In case you’ve blocked out that painful memory, that was just before the catastrophic waterfall decline which took the S&P 500 index down to a 6 handle. But from all the historical studies that I’ve seen, a low VIX doesn’t really mean anything, not in the way that a spike high denotes a panic bottom for equities. After going through some absolutely insane volatility we are once again returning to historically normal ranges so I don’t think there’s much edge here.

IPO Pipeline
The private equity groups are getting more and more of their holdings gussied up for public offerings. If you know how shrewd an investor these institutions are, you do not want to be on the other side of their average trade. After all, timing the market is pretty much all they do. They fund or take unloved companies private and then when the public sentiment is ripe, they sell them back again for a higher price.

In the following weeks, Fortress, KKR, Blackstone and Bain Capital will be bringing a half a dozen IPOs online. Unlike the traditional IPO where a company raises money for expansion, these are exits where the firms that took an opportunistic stake want to get their money back with a healthy return. Usually a healthy IPO market is a sign of a healthy equity market and only when it become excessive should we take a contrarian stance. But now, I’m watching the number of IPOs and the welcome they receive in the market as a gauge of the mood out there.