Trader’s Narrative

If it is Friday then this is the week’s sentiment round up:

Sentiment Surveys
If you’ve been monitoring the mutual fund flow data, you wouldn’t be surprised to see the AAII continue to show the average US retail investor as decidedly unimpressed and cool about the rising stock market. This week the pessimist camp grew slightly to 41% while the bulls shrank by 9% points to 35%.

The latest Investors Intelligence bulls edged off the half way mark to 48.9% while the bears increased slightly to 24.4%. This is nothing really noteworthy by itself, except to mark the continued 2:1 bull to bear ratio we’ve been seeing for the nth week. So far, the market has not succumbed to this flashing red light and it is anyone’s guess when it will finally decide to do so.

I mentioned the NAAIM Survey of Manager Sentiment as a lesser known sentiment measure at the start of the year. And it is time we updated it to see what it can tell us about the mood of active investment managers in the US:

At the end of September the NAAIM was +86.41 and has since dropped slightly to 68. It is difficult to see in the chart above, but the last time this sentiment measure showed as much bullishness was back in - Yikes! - October 17th 2007 (when it was +86.93). And it was surprisingly, even higher earlier in that year when it reached +90 in January, February and May 2007.

The RBC Consumer Attitudes and Spending by Household (CASH) survey jumped 11.8 points to 51.8 in October - this, after falling to an all time low of 1.6 in February 2009. The monthly RBC Index measures consumer attitudes on the current and future state of local economies, personal finance situations, as well as their savings and confidence to make large investments.

Finally, Consensus which measures futures traders shows them to be 72% bullish. Once again, raising the hairs on your back, that’s the highest level since October 2007.

Option Traders
The puts and calls are flying furiously but there is a definite skew as option traders favor the bullish side of the derivatives. Both the ISE and the CBOE measures of option activity show a continuing crowding on the long side.

The ISE sentiment index (equity only) closed at 221 this Friday, implying that more than twice as many calls were purchased to open a trade as puts. Meanwhile, the CBOE (equity only) put call ratio fell to 0.47 on Tuesday - among the lowest single day ratios for the whole year… so far.

Rydex Traders
But the itchy trigger fingered Rydex traders have suddenly gotten cold feet. Even as the market has recovered smartly from its latest set back, the Rydex Nova/Ursa ratio has fallen as these short term market timers eschew the long side:

Conclusion.
Cross currents in sentiment are completely normal and something that any contrarian has to get used to. However, the current market’s sentiment conditions are especially confusing as it seems that one measure simply contradicts the one before it. When you don’t see an edge, don’t push your luck.

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.

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Here’s an up and coming sentiment tool that I discovered recently. It is released weekly by the National Association of Active Investment Managers (NAAIM), a non-profit association of registered investment advisors formed in 1989. Since the (200 or so) member advisors provide active money management services to their clients, as opposed to buy and hold, they position their portfolios according to their opinions of the market’s future. In reality every portfolio is actively managed because there is no way to be passive.

In any case, each week on Wednesday, the advisors communicate their equity exposure by choosing one of the following answers:

• 200% — Leveraged Short
• 100% — Fully Short
• 0% — 100% Cash or Hedged to Market Neutral
• 100% — Fully Invested
• 200% — Leveraged Long

Their answers are then averaged to produce the NAAIM Trend Survey of Manager Sentiment:

Although we only have two and a half years of sentiment data and a relatively small sample size, this sentiment indicator shows promise. To start its extremes correspond to tops and bottoms in the S&P 500. For example, when active managers reduced their exposure to “neutral” in late August 2007 and July 2008, we saw the S&P 500 find its feet again.

But the latest active managers sentiment is somewhat troubling because even as the market weakness has continued for several months, they have positioned their portfolios more and more aggressively long. Once again we are seeing that we do not have a “wash-out” or complete capitulation. On the contrary, everyone it seems is even more hopeful… as the market falls even lower!

Although the NAAIM data is weekly, it comes out with a delay. The latest result is for January 14th 2009. I’ll update the chart when the new data is released or when it tells us some other interesting things about the market.

If you want to get more information or download the raw data to play around with it, you can do so at the NAAIM website.