Trader’s Narrative

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′

I took a few days off (hope you didn’t miss me too much). Let’s catch up by looking at the important sentiment developments:

ISE Sentiment
I mentioned the ISEE during last week’s sentiment overview when it increased slightly as the market fell, showing that retail option traders were seemingly not worried. Even more bizarre, during the past shortened trading week as the market staged a strong recovery, the ISEE value actually fell.

Part of the explanation for this aberrant behavior may be that I’m looking at the “All Securities” data for the ISEE, rather than the “Equities Only”. The latter measure showed no similar increase for the week of May 23rd.

CBOE Put Call Ratio
Again, in contrast to the ISEE’s behavior, the CBOE equities only put call ratio showed this past week that traders became more bullish as the market rose. Although not the ideal, this is the normal pattern.

The put call ratio fell to 0.59 - approaching levels of bullishness which have previously caused stock market rallies much difficulty.

Hulbert Newsletter Sentiment
According to Mark Hulbert, the Hulbert Stock Newsletter Sentiment Index (HSNSI) has almost doubled from +16.2% to +31.2%. And it did so from mid May to the end of May 2008. Although this is an significant increase, I don’t think it presents us with a situation commensurate with market top.

To give you an idea, during mid to late April 2006 the HSNSI reached +73.2% - when the S&P 500 index soon after fell from 1325 to 1225. And during the bear market bottom in October 2002, it fell below -60%. So all I can say from the current reading is that more newsletter editors are jumping into the bullish camp but still not enough to cause serious problems.

AAII
According to the American Association of Individual Investors’ sentiment survey, there are now 31% bulls, down 15% points from last week’s 46% bulls.

This is a welcome reprieve, especially as it is accompanied by a lower market. Had this key sentiment survey remained unchanged or actually increased in bullishness, the sentiment tone would be definitely different.

Investor’s Intelligence
Similar to the AAII survey, the II sentiment measure fell from 47% bullish to 37.9%. I was worried about this since last week’s number was almost 50%. The keepers of this measure, the editors of ChartCraft, Burke and Gray agree with my general take on the market’s sentiment:

“While the sentiment is moving away from a bullish reading it is not yet close to calling for a market top”

I continue to see a lot of long term positives for the market and continue to believe the March bottom to be a major one. What I suspect we are seeing is a (hopefully) shallow pull back or pause before the next leg up.

Magazine Cover Indicator
Uh oh. Anyone long crude oil or any traditional energy related equities should be worried.

The Economist isn’t the most widely read publication but their cover stories still do carry weight - in a contrary sense most of the time. The price of crude has already tapered off and I suspect this will be either a significant top or at minimum a longish pause.

There are, of course, other signs that the whole energy rally has run its course. There are several technical signs, including the increasingly sharp slope of the trendlines as well as ominous candlestick formations.

Here is this past week’s important sentiment data:

Stock Timing Newsletters
The Hulbert Stock Newsletter Sentiment Index (HSNSI) was at 27.5% at the start of the week. Meaning that the average stock timing newsletter was recommending to their readers that they be long the equity market with 27.5% of their portfolio. This is where they were the previous week, before the powerhouse performance that the stock market put in rocketing higher with 90-90 up days.

So from a relative point of view, that performance did nothing to impress the average stock timing newsletter editor. This is bullish from a contrarian point of view. On an absolute level however, the HSNSI is well above the -29.4% it reached in mid March 2008. But it isn’t yet yet high enough to give me concern.

AAII
The weekly American Association of Individual Investors sentiment survey has suddenly veered sharply into a bearish stance. It wasn’t that long ago that we had more than 50% of respondents in a bearish posture, but now that number has withered to only 28%. To find a time when the AAII survey was more bearish we’d have to go back to October 2007 when the market made its swing high.

Although it is just one measure of sentiment, it makes me uneasy. I’m glad that I’ve already reigned in my enthusiasm.

ISEE Sentiment
Inside last week’s sentiment overview I mentioned that the CBOE equity only put call ratio had declined to dangerous levels (for the bulls that is). That is confirmed by the ISE sentiment data.

On Monday it reached a high of 158 - meaning that retail option traders were buying to open 158 call options for each 100 put options. It has since fallen to 117 on Friday and the 10 day moving average is still fairly low but still, it does give me another reason to be cautious here.

Insider Buying
I’m talking about the legal variety here, the kind that is communicated to the SEC and tracked by various services like Vickers/Argus and Insider Insights. Insiders have been actively buying during the markets most recent fall. Since insiders have an intimate knowledge of their market and businesses this is a big positive sign. On the other hand, had they instead sold en masse while the market fell, it would mean that we were not close to a bottom and had more to go.

According to Argus’ data for the past two months, insider selling to buying is 1.40:1 - meaning that for every $1.40 equivalent sold by an insider during that time, $1 was spent on buying stocks. Since insiders are normally net sellers, any decrease in this ratio is what matters. According to Argus, it is bullish anytime insiders are selling less than twice what they buy.

To add another to the set of indicators that compare the present market conditions to those of the end of the 2002 bear market, the current insider ratio is very similar to what it was then.

Conclusion
So while in the medium to long term, the viability of a continuing rally is still looking pretty good, there are gathering signs that we may backtrack a little or pause before fully exploiting it.

This week sentiment recovered from the abyss into which it had fallen. This isn’t surprising considering the strong lift-off the market had last week. But even so, it doesn’t yet give us any reason to doubt the veracity nor the potential of the rally to continue.

Hulbert Newsletter Sentiment Index
According to Mark Hulbert, the Hulbert Stock Newsletter Sentiment Index (HSNSI) was -22.5% on Monday, March 24th, 2008.

On March 10th, 2008 when we had the lowest close in recent history, the HSNSI was a little bit lower at -25.9%. Which means that although the market has recovered from such lows, the average market timing newsletter writer is still very much bearish and recommending to their subscribers that they in fact short the market in their portfolios!

This is even more significant when we compare the reaction this rally has provoked to the previous rally in mid January. Right after the market recovered from those intra-day lows and went higher, newsletters quickly jumped on the bandwagon and the HSNSI increased right along with the rally more than 22% points.

This is exactly what I was referring to when I answered Jim’s question about trend and why I’m not bearish in the current market condition.

Sentiment Surveys
The AAII retail investor’s sentiment survey continued to recover with an increase in optimism: 42% were bullish and 34% bearish. This puts them square in neutral territory.

The II (ChartCraft’s newsletter sentiment measure) similarly recovered with a small decrease in the number of bears (41%) and a small increase in the bulls (36.7%). But unlike the AAII, the newsletter editors are still very much at extreme levels of bearishness which have historically coincided with market bottoms.

Although sentiment has shifted from the lopsided scenario we had, I don’t think this means that the rally it birthed is in danger. For the market to go up we need people to start buying again and for that, they need to not be so afraid. That, however, is different than a quick shift from one extreme side of sentiment to the other.

ISE Sentiment
This week we’ve seen a consolidation after last week’s rapid recovery. The ISE Sentiment Index, however, is showing that this has lead the retail option traders to quickly lose any excitement for the rally:

ROBO Put Call Ratio
This proprietary measure created by Jason Goepfert of SentimenTrader.com keeps track of what the small retail option traders are doing.

The most recent data is showing that the retail investor is very worried. The ROBO put call ratio is 0.91 - that’s from 0.68 in mid February 2008.

To find similarly pessimistic times when the retail investor was buying puts so frantically, we’d have to go back to early 2003, just as the bear market was coming to a close.

Because of the delay in getting OCC data, this reflects what was happening in the option market last week. But it is nonetheless useful on an intermediate to long term time horizon.

On Wednesday - February 13th - after 3 consecutive up days, I mentioned the peculiar way that option traders were in denial of the rally and of the likelihood of seeing a pause:

It would be very normal for the market to pause and digest this short term move up but the negative sentiment is undeniable.

We got the “pause and digest” the following day on Thursday and today. So to dive into all that negative sentiment, here is the stock market sentiment recap for this past week:

LowRisk.com
I mention this sentiment survey sparingly because it is very jittery and much less famous than its peers. But this week’s reading of 64% bears and 24% bulls reminds me of the last time that bearish sentiment was 60% (June 2007).

Unlike then, this week’s bullish ratio (bulls divided by the sum of bulls and bears) is quite high at 27.27%. But there is no denying that the respondents are very gloomy about the Dow’s prospects. Their median guess of the Dow (closing value February 22nd) was 11852 - well below the Dow’s January swing low of 11,970.

Investor’s Intelligence
If you’ve been keeping up to date with these sentiment overviews then you know that the II survey has been insistently and stubbornly stuck with a clear bullish consensus. For contrarians, that has been disconcerting not only because II is a major sentiment survey but because it contradicted all the other surveys.

This week it seems “reason” has finally prevailed in newsletter land. According to ChartCraft, the keeper of this indicator, the bears now account for 35.6%, and the bulls 36.7%. While that may seemingly put them neck and neck, the historical data for this survey gives us a decidedly more bullish interpretation.

Newsletter editors are naturally bullish by nature, after all, optimism sells. So it is almost impossible to find less than a third of them bullish at any point in time, no matter what the market condition. The current percentage of bulls is as low as it was in the summer of 2006 and 2002 (and no other time since). So I can comfortably say that the II is officially flashing a contrarian buy signal - finally!!.

AAII
Meanwhile, the AAII (retail investors) sentiment has finally decided to come up for air from the depths of despair it had sunk to in January 2008. The AAII sentiment survey spent 5 consecutive weeks (December 21st, 2007 to January 18th, 2008) being 50% or more bearish. The bears are now “only” 42% (with the bulls at 33%).

We’ll have to wait a few more months to see if the stock market follows the previous script or if we stray. According to the above chart, we could find the S&P 500 at 1558 by June 2008.

That’s not a prediction, by the way. I’m just extrapolating from the historic averages. But it could turn out to be prescient, so write it down somewhere or bookmark this so you can come back and mock me

Consumer Sentiment
The most recent Reuters/University of Michigan’s consumer sentiment survey was released today and it shows a stumble from 78.4 to 69.6 - the lowest since 1992!

As I’ve discussed before, consumer sentiment measures are a contrarian indicator. By the time they reflect doom and gloom, it is too late to sell, and in fact a better time to buy.

Whether that is because of the time lag built into this kind of survey or whether it is because of the forward discounting ability of the stock market (or both), the historical evidence shows that significant lows in consumer sentiment are buy signals for stocks.

I’ll going to write more about this indicator soon.