Trader’s Narrative

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.

For economic and market news and to see what interesting reading you may have missed last week, check out the list below. To see it all, go to news.tradersnarrative.com:

• 18 US Banks Miss TARP Payments
• The Missing Paul Tudor Jones Tape (he uses Elliott Wave!)
• Initial Public Optimism - The IPO Market Bounces Back
• Will “Cash-on-the-Sidelines” Really Drive Stocks?
• Get a FREE Subscription to Futures Magazine (limited time for US residents only)
• Taibbi’s Upcoming Article on Naked Short Selling
• Good Trades are not Sexy
• Larry Summers and the White House economic team
• FREE 50-page eBook: The Ultimate Technical Analysis Handbook (lmt time offer)
• Contrarian analysis of current gold market

The above is a tiny sample, for the full list, follow the link to news.tradersnarrative.com:

And remember to check back regularly since there are interesting links added throughout the week. If you are a twitter user, add the news.tradersnarrative.com twitter stream to get new stories in real time.

The Week Ahead:

While the US market has been incredibly strong, the Chinese stock market, by comparison, makes it look downright flaccid.

A few months back we looked at the Shanghai Stock Exchange Composite and noticed that the Chinese equivalent of the Coppock Curve had turned positive. As well, just a few weeks before this long term signal was given, we had another important positive development: a golden cross. Since then prices have climbed in what can only be described as a trend followers dream.

That was a good place to go long Chinese equities (green up arrow). Since then the Shanghai Composite has climbed by 37%. But if you were reading this blog way back in early November 2008, I wrote about the extremely negative sentiment in China towards stocks and how this was a great contrarian indicator.

Back in November 2008, the Shanghai Composite was trading around 1700 - pretty much nailing the exact bottom (green up arrow). With the Shanghai Composite now trading at 3438, that’s 100%+ in 9 months.

So obviously, everyone all of a sudden loves Chinese stocks now. Their IPOs are popping like crazy. Just today China State Construction Engineering opened at 6.70 yuan, well above its initial public offering price of 4.18 yuan and closed on heavy volume at 7.30 yuan. It is telling about where the future global epicenter will be when the largest global IPO so far this year is Chinese.

A good old IPO frenzy is a sure sign of a sentiment extreme, just like billboards lampooning the stock market are a contrarian indicator at the bottom. But there are other signs of caution.

The last time the Shanghai Composite closed this far from its simple 50 moving day average was way back in October 2007… just as the market was making its top at slightly under 6100. And the last time the index closed this far above its 200 day simple moving average was in November 2007. Again, not a good time to be long this market.

Also, notice that simple support and resistance highlights this level as congestion going back to the spring of 2008. As prices were falling last year, they were met with strong support around this area. The Shanghai Composite thrashed about as prices disturbed their smooth downtrend. So this same area is now resistance as it acted as support before.

There is no question that things are really stretched at this point in Chinese equities. Of course, price can always continue but if you’re sitting on nice gains, it doesn’t make sense to continue to ride them as the odds are now totally skewed against you. The time to go long Chinese stocks was when no one wanted them, late last year as I pointed out back then.

From a long term perspective, having being blessed with both the “golden cross” and the Coppock Guide upturn, the best is yet to come. But not before we have a pull-back to shake out the weak hands. So unless you are ready to ride so major turbulence, it would be smart to lighten up here and ring the cash register.

If you’re not going to listen to me, consider Jeremy Grantham; who was correctly pessimistic and called the bear market as well as the spring rally this year. In his recent report, the chief investment strategist at Boston-based institutional money manager GMO writes:

Deciphering the strength of the Chinese economy will also play a major role in formulating our view of any future relative strength of emerging. My colleague, Edward Chancellor, strongly suspects that the Chinese economy is dangerously unbalanced and very likely to come unhinged in the next few quarters, surprising the pants off investors. On the other hand, the strong longer-term case that I outlined in “The Emerging Emerging Bubble” 15 months ago seems intact. I suggested then that emerging equities would sell within fi ve years or so at a distinct P/E premium to celebrate their obviously superior GDP growth compared with that of an aging developed world. Emerging market equities are already selling at a modest premium to EAFE and the higher quality half of the U.S. equity market.

Being pro-emerging yet anti-China is a dilemma for us; we are working to resolve it. Meanwhile, emerging equities, like most risky asset components, are moderately overpriced. We in asset allocation may, however, push our luck in emerging – particularly ex-China emerging – using inertia to reduce our current modest overweight. If we do this, it will be out of respect for the high probability that emerging equities will sustain and increase their overpriced level relative to the rest of the world.

You can download the complete report from Jeremy Grantham from the FREE Trading Resource Section (in the Reports folder). There is a lot of other stuff you might like as well, so take a look around.

In a strange twist of events, the most notorious file sharing website, The Pirate Bay, is being bought out by a small public company, Global Gaming Factory for about $7.8 US million.

According to the spokesperson for TPB, Peter Sunde, GGF approached the owners of TPB a few months ago and negotiations finalized recently with the transaction expected to be completed by August 2009.

It will be interesting to see how this will effect the ongoing attempts by the RIAA/MPAA to eliminate sites like the Pirate Bay. Obviously, as a public company, they will be an easy target. But according to the unofficial sources, the Pirate Bay is going to decentralize their technological structure even more so that a separate company is handling the trackers and another the torrent listings.

Source: AktieTorget

It remains to be seen if this is a way for the Pirate Bay to continue its swashbuckling ways or if this means a change in their business model. In any case, if you’re brave enough, you can now own a part of this ongoing saga.

The shares of GGF jumped after the announcement but looking at the long term chart (above) there is a massive amount of overhead resistance.

For economic and market news and to see what you may have missed last week, check out the list below. It is just a few choice examples from news.tradersnarrative.com:

• What Does Climate Change Have to do with Goldman Sachs?
• Barry Ritholtz Podcast Interview
• Five Pitfalls of Developing Traders
• KKR Goes Public Through IPO Backdoor
• Get a FREE Subscription to Financial Magazines
• Spotting Trend Reversals With MACD
• Obama’s Financial Reform
• End of Nortel - Sale to Nokia & Delisting
• Buffett: US Economy In “Shambles” .. No Signs of Recovery Yet
• What is the difference between a triangle and a pennant?
• Free trading videos
• Volcker Not Calling Shots in Financial Reform
• Central Banks Can’t Control the Market

For the complete list, follow the graphic below:

And remember to check back regularly since there are interesting links added throughout the week.

Week Ahead