Trader’s Narrative

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?’

There’s a lot to cover in this week’s sentiment overview, so let’s get started:

Investors Intelligence
This week’s ChartCraft’s survey of stock newsletter writers delivered only 29.7% bulls - up slightly from last week. And almost unchanged from last week, 44% bears.

Market Vane
Market Vane dropped again to the low 30’s - a level last seen in October to November 2008 when the market made a short term spike down. That’s relatively low but not on an absolute level since it fell to sub-20 readings in the last bear market bottom between 2002-2003. To read more about Market Vane and its origins, check out A Brief History of Contrarian Analysis.

AAII
But the most fascinating and historic reading comes to us from the AAII weekly survey. The latest American Association of Individual Investors (AAII) data shows what can only be describe as total and utter capitulation. As of Wednesday (March 4th, 2009) 70% expected the market to continue to fall, while only 19% continue to see better times ahead.

The only data point from the AAII survey that approaches this level of gloom is back in October 19th, 1990 when a paltry 13% of respondents were bullish and 67% were bearish.

Source: SentimenTrader.com

ISE Sentiment
In contrast, the ISE put call ratio (also known as the ISE Sentiment index) continues to tread water, seemingly oblivious to any risk. The only data that can be interpreted as slightly bullish is that for the second time this year, it fell below parity - barely. On Wednesday March 4th, 2009 the ISE Sentiment fell to 95. The only other time it fell below 100 was back in February 3rd 2009 when it hit 97. Since January 1st 2008, it has only fallen below the parity level ten times.

CBOE Put Call Ratio
Similar to the ISE data, the CBOE put call ratio shows no sign of flight to safety. On March 5th it reached 0.90 - a relative high but by no means a level which shows a serious sense of risk.

Corporate Insiders
Once again corporate insiders stepped up to the plate to buy their companies’ shares. Although there is a noticeable spike in purchases (relative to sales), I wonder if it means anything because it is another in a series of similar spikes that we’ve seen going back to November, July and March 2008.

TED Spread
This indicator has fallen off everyone’s radar - and for good reason. Right now the TED spread is still high at around 1.0 but it is far from the peak of 5.0 reached at the zenith of last year’s credit crisis. Still, relative to its own long term average it is still very high since it averaged around 0.4 for the past few years.

Hulbert Sentiment Index
The bad news is that at the start of the week, the Hulbert Stock Newsletter Sentiment Index (HSNSI) is at -20%. Meaning that on average, the newsletters that time the market are advising clients to short the market with 20% of their portfolio. Although this is a low number, HSNSI was more than twice as low last July. So while the market has continued to fall, stock timing newsletters are half as pessimistic.

Compared this to the previous significant market bottom in March 2003. On March 10th, the HSNSI was -19.2%, almost equal to where it stands now. But back in July and October 2002, the HSNSI was -15% and +20% respectively. So clearly, we aren’t seeing full blown capitulation from market timing newsletters.

Magazine Cover
Business Week is one of my favorite magazine indicators because it has such a rich contrarian history. This week’s cover isn’t as pessimistic visually as the corresponding article.

Inside, the cover article goes over the failure of the usual indicators, whether sentiment, technical, monetary, etc. to be act as guides in this past bear market. It quotes experts ranging from James Stack of InvesTech, the Leuthold Group, and TrimTabs’ Biderman who each metaphorically throw up their hands in frustration. The gloomy outlook is punctured by a few positives but the conclusion is:

A more probable outcome is the one drawn from the narrow history of bear markets that grew out of financial crises. In it, the bear scenario continues to play out until the bull takes over, with more debt busts and government trial and error until things get set right again. That could mean two more years of bouncing around and then another six or so before the Dow is back above 14,000. Not long ago, such an outcome would have seemed unimaginably bleak. Given the other possibilities, it doesn’t seem so bad now.

Source: When will the the bull return?

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Granville said it best in his book, A Strategy of Daily Stock Market Timing:

“When it’s obvious to the public, it’s obviously wrong.”

Since we talk a lot about sentiment and contrarian sentiment, lets step back and review where this idea came from and how it developed from its origins.

Charles H. Dow
The main principle behind contrarian analysis and sentiment (two sides of the same coin) comes from Charles H. Dow’s work on distribution and accumulation. The same ideas that underpin the Dow Theory. I’m sure you’ll also notice the similarity between these ideas and Weinstein’s stage analysis which breaks up a movement of a security into four parts.

According to Dow Theory, major market movements start with an “accumulation” phase where insiders, and other knowledgeable traders or investors start to buy shares. Since at this point the average public sentiment towards the market is negative, they are able to accumulate shares without significantly pushing prices higher.

Eventually the general sentiment starts to tip as more and more people start to realize that something has changed. This is the stage at which trend followers jump on and start to push up prices further. The trend continues and feeds on itself, perpetuating until it reaches a crescendo.
Continue reading ‘A Brief History Of Contrarian Analysis’

Sentiment Surveys
For the past few sentiment overviews, I’ve been bemoaning the lack of bearishness from retail investors. According to the AAII weekly survey, we did see a huge spike up to 60% bearishness, but then a very quick nonchallant attitude took over Mom and Pop investors across the land. For some strange reason, as the bear continued to maul markets with blood curdling ferocity, they didn’t care. Or maybe they were numb from shock already.

It was not surprising then that the market broke through the October and November lows. This week’s AAII numbers show an increase in fear (finally!). It is important to note that they came in on Wednesday - before the elevator drop through previous support levels - so it is curious to guesstimate where sentiment would be if the survey was administered afterwards.

AAII bulls came in at 24.37% and the bears at 57.14%. While this is a good development, as I’ve said for the Nth time, what we really need to see is the market recover and a commensurate increase (or plateau) in bearish sentiment. That would give me confidence in any ensuing rally. But if once again people start clinging to every uptick as a hopeful recovery, it will be short lived.

ChartCraft’s Investor’s Intelligence sentiment measure was mostly unchanged with 31% bulls (a tiny decrease) and 43.6% bears (slight bump up from last week). This survey came out on November 18th and it continues the slow trending decrease in bearishness from October.

Of course, the completely useless Citigroup Panic Euphoria model continued to impersonate a dead parrot’s heartbeat monitor. If Vikram wants to cut costs at Citigroup (C), he could start at worse places.

Market Vane’s bullish consensus sentiment dropped slightly to 40%. During this downturn this measure of sentiment has also stubbornly remained above previous panic levels. The lowest it reached was 32%, a far cry from the 20% range we saw in the darkest hour of the previous bear market.

Options Market
The options market continues to confound. While the CBOE equity only put call ratio increased to 1.16 as a result of Wednesday’s 6.12% plunge in the S&P 500, the next day’s carnage which took the index down 6.7% actually saw the put call ratio fall to 1.05.

The same pattern was noticeable in the ISE Sentiment index. The ISE call put ratio fell to 78 on November 19th - low but not extreme - but then it rebounded the next day even as the market took a more intense drubbing.

The options market continues to act crazy. Although put call ratios don’t walk hand in hand with the market every day, this is just bonkers. It is almost as if we’ve entered an alternative universe where previous market indicators and measures mean nothing.

Volatility
Volatility hasn’t imploded (yet). In fact, the VIX is back at previous highs last seen in late October. The thin layer of good news may be that while the market has broken to new lows, volatility hasn’t.

It wasn’t long ago when 45 was considered “extreme”. Since mid October the VIX has stayed above “extreme” and redefined it. Beforehand, we had broken above 45 on only four occasions. So yes, this is an absolutely unprecedented market.

Value Investors Peek Out
The ever cautious head of Fairfax Holdings (FFH), Prem Watsa, has peeked from under the covers and decided to remove the protective hedges for the firm’s equity portfolio. While Fairfax still holds the bulk of their assets in fixed income, it is another sign of valuations coming to attractive levels. Watsa is compared by some to Buffett because of his cautious nature and his strict adherence to a value oriented investment philosophy.

Watsa wrote to Fairfax shareholders: “While we believe the recession may be long and deep, we also believe that stock prices may have already discounted the worst of the economic decline. As value investors, we are finding an incredible number of investment opportunities across the world. That said, in the short term we recognize that stock markets can continue to fall significantly.”

To get similar news, watch news.tradersnarrative.com - that’s where I put links to interesting articles, breaking news, reports, etc.

According to sentiment, it is time to sell bonds (and buy stocks).

Bond Market Sentiment
A few days ago the Hulbert Bond Newsletter Sentiment Index reached 47.4% — that’s four times the average sentiment over the past year and eerily enough, it is a repeat of what happened last year at this time. We had a slightly higher level of bullishness last November as bond prices carved out a major top.

Two other bond sentiment measures also show a dangerous level of bullishness. Market Vane sentiment survey shows 68% bulls - you’d have to go back to 2005 to find a higher level. And Consensus Sentiment shows 63% bulls, down from a recent peak of almost 80% but still quite high.

According to contrarian analysis, you want to fade the crowd and that would mean selling bonds.

Chart Request
In the comments section of my update on the timing the stock market using the rate of change of the 10 year T-Bonds, scood asked for a chart of the same covering the 2001- 2004 timeline:

It depends on how you want to interpret that signal. One could see it as a failure or success since price meandered before continuing to rise again. If you want to be really strict, it could be interpreted as a failure since price didn’t immediately go up.

In any case, nothing is 100%. This and other indicators are mere guides and should only be used as such.