Trader’s Narrative

Here’s this week’s sentiment summary:

NASDAQ:NYSE Volume
I touched on the relative lack of volume and how this has historically marked tops, rather than spurred on rallies. Another troubling volume development is the ratio of volume on the Nasdaq compared to the NYSE. We are seeing a spike in this ratio, meaning that Nasdaq volume is significantly more than NYSE volume. Since the Nasdaq represents the riskier side of the market, this has usually meant that there is too much froth in the market.

Sentiment Surveys
Last week I pointed out the danger of having the AAII remain at 53% bullish when the market had gone down slightly. Although this week the AAII respondents were slightly less bullish (45%) it is good to see their excitement abate in the face of a week that saw the market go up.

This reversal however only slightly dilutes the contrarian bearish meaning of this indicator. We are still at a very high level of bullishness. Simply by receding from the extreme level of bullishness that we saw last week does not eliminate the topping signal that the AAII is giving us at this point. After all, it was in October 2007 when we last saw this sentiment measure at such heights.

Investor’s Intelligence, the measure of newsletter sentiment compiled by ChartCraft, showed little change going from 44.4% bullish to 46% bullish.

Hulbert Newsletter Sentiment Survey
In contrast to the sentiment surveys mentioned above, the Hulbert Stock Newsletter Sentiment Index is continuing to suggest that newsletter editor are still either skeptical of the market’s recovery or not really excited by it.

At the start of the week, the HSNSI was 16.2%, meaning that the average market timing newsletter was suggesting to their clients being long just 16.2% of their portfolio. This is much lower than the 27.5% which they were recommending in late April, even though at that time the market was lower than it is now.

Slicing and dicing the newsletters, Hulber finds that the stock market newsletters with the best track record of timing the market are continuing to be bullish, while those that have lagged buy and hold are much less so. This gap in sentiment and performance has, however, significantly diminished from mid-March - when the market hit its inflection point.

Is LowRisk Dead?
A reader already asked about the lack of updates from LowRisk. I emailed Jeff Walker, the keeper of the data and when or if I receive a reply I’ll write a follow up. The last update on their site is for March 23rd 2008. I haven’t received any email updates either - I’m subscribed. In any case, LowRisk was never one of the major sentiment surveys that I relied on. It was a bit too volatile and no one except Walker knew the size of the sample size.

Magazine Cover Indicator
Here’s an interesting magazine cover for analysis (below): “Barbarians at the vault”. It is the latest Economist cover showing a bank being besieged by a horde of angry “barbarians” carrying banners with such slogans as :

• Skin the fat cats!
• Just say no to CDOs
• Regulate now
• Salary limits

The building is on fire, there is a column being pulled and there are sledgehammers being taken to its pillars. Pretty powerful imagery. I wonder how it will play out with the Philadelphia Banking Index being where it is:

Check out the Economist’s “prowling bear” cover in 2006. As disclosure, I’m long the AMEX Financial Select Sector ETF (XLF).

Measuring the volume ratio of the Nasdaq and the NYSE goes back to the early days of technical analysis.

At its genesis, the Nasdaq was seen as a lesser exchange where smaller, younger and riskier companies who had yet to prove themselves got listed. The NYSE on the other hand was where these companies all wanted to be one day… if they met the listing requirements.

Advancements in technology have made such impressions anachronisms as the Nasdaq has become the “big board” for innovative companies in software, hardware and biotech.

While the image of the Nasdaq as a lesser stock exchange may been lost, the merit of comparing the two exchanges volume remains.

As you can see, during times of great market stress; when fear and loathing has gripped everyone’s imagination, the ratio is lopsided with the Nasdaq having relatively little trading compared to the NYSE. The end of 2002 and the first few months of 2003 are a good example:

The logical explanation offered is that people gravitate towards the NYSE in times of heightened risk because it contains well established companies.

The latest spike low - reaching almost parity - came on March 20th, 2008, which surprisingly was after the sharp declines. While a spike low is intriguing, it is not the same as a resetting of the volume ratio to a lower handle.

But then again, that would dovetail with the theory that what we are seeing is not a bear market bottom or a bear market at all but rather a very brutal correction within a cyclical bull market.

The previous time I mentioned the Nasdaq to NYSE volume ratio, it had just signalled (correctly) that October 2007 brought with it a very high probability of a top.

With the impending FOMC decision, traders are going to be twitchy and nervous. Although a 25 basis point cut is baked in, until we get confirmation, the market will probably not trend.

If you’ve been reading the blog for the past few weeks, you’re no stranger to my repeated bullish commentary. The market seems to have bottomed right on time with the Nasdaq composite sitting +150 points higher now.

So lets see what the last week brought us in terms of sentiment data:

AAII Sentiment Survey
With the market powering ahead last week with back to back up days, sentiment has shifted. The AAII respondents are neck and neck with 41% bullish and 40% bearish.

Put Call Ratio
The options sentiment ratio spiked up to almost 1.0 in mid November as people rushed to buy puts. But now the equity put call ratio has fallen by almost half. This isn’t automatically a negative as the market has recovered and forced people to back down from their gloom & doom forecasts.

Nasdaq to NYSE Volume Ratio
Although I haven’t said much (or anything really) about this sentiment gauge, it is one of the oldest ones around. The theory is that the two exchanges represent different kinds of equity - Nasdaq was once the platform for unproven, young, and therefore, riskier listings and the big board, the place where all companies wanted to graduate to, the place where the largest, most stable corporations called home.

Of course, over time the difference between the two exchanges has been pretty much eliminated. But this indicator is still going on strong. So by following the ratio of volume on the two exchanges, we can gauge the level at which investors seek risk.

A spike lower in the ratio means that investors are fleeing Nasdaq stocks for NYSE ones and a spike up, the reverse. The most recent market decline in mid November saw this ratio dip to 1.20 - not the lowest it has been, but still very close to the 1.0 level which is the “uncle” point.

More importantly, with the exception of the spike low in November, the ratio has been scraping the ceiling. We’d have to go back more than 6 years to find similarly high readings.