Trader’s Narrative

Alright, before we start the new trading week, here is the sentiment overview of the concluding week. There is little to write about because little has changed since the previous overview:

Sentiment Surveys
According to Investor’s Intelligence, newsletter editors are pretty much were they were when we did an overview of sentiment last week. With 36% bullish and 37% bearish, we continue to have very good grounds for a rally.

Similarly, the AAII survey shows 37% bullish and 39% bearish. It is interesting to see these two (II and AAII) sentiment gauges now paralleling each other. It wasn’t that long ago that they were sending mixed messages and everyone, including me, was trying to make sense of it.

Consensus, which was showing the lowest bullish readings since 5 years ago, recovered to 27% but is still in extremely bullish territory.

Odd Lot Short Sales
One indicator which is blinking red against the bullish scenario is the NYSE odd lot short sales. These are small amounts of stocks which have been sold short. Since retail investors or traders are usually behind these, it is safe to assume that no complex hedging strategy is behind it. But rather, their expectation is that the market will fall.

Recent data shows the odd lot short sale approaching levels which have previously marked a top. But the good news is that this indicator is very short term in time horizon. We’re talking days or weeks at the most here. Which is hardly surprising considering where we are:

Right below the tenacious resistance levels at 1400 which have repelled previous rallies. I don’t pretend to know where the market is headed but the best case for the bulls would be a pause just under that resistance level, and then another assault to break through the barrier and go higher.

If you squint you may notice that there are technically lower highs and lower lows. Of course we have the December 2007 swing high, then the early February 2008 top, followed by the late February 2008 top, and then finally where we are now. If it turns into another top… well, that would be very messy for the best laid bullish plans.

Doom & Gloom
Here’s an interesting headline from ABC News: “Are We Heading Into a Depression?” It juxtaposes the infamous image of the depression in our minds with that of today.

Before you rush out to buy cans of preserves and stock-up on cheese, remember that it is much easier for the media to sell fear and gloom than positive news. And that from a contrarian perspective, such bombastic headlines are actually precursors of better times ahead.

And by no means is the above example an isolated case. The media is replete with such stories. Just a few days ago I showed a BusinessWeek article which immediately called into question the nascent recovery in the stock market.

I know this is a bit late but lets cover last week’s sentiment landscape:

Hulbert Stock Newsletter Sentiment
According to Mark Hulbert, there is a stark contrast in the land of newsletters. The newsletters with the best track record in timing the stock market are bullish with an average 83% equity exposure. Contrast that with newsletters with the worst track record which are bearish with an average of only 9% exposure.

LowRisk 30-Day Outlook
Last week this survey had 64% bearish and only 18% bullish. That was a head spinning change of mind from the week previous to that when there were 34% bears and 50% bulls. As I’ve said before, LowRisk is a very volatile sentiment survey but nevertheless, this level of bearishness should be noted. The last time we saw something similar was back in August 2007.

Investor’s Intelligence
In contrast, newsletter sentiment as judged by II shows 51.1% bulls and 26.7% bears. Although that is down a bit from the 60+% of bulls the survey was showing just a while ago, it is still quite bearish from a contrarian point of view.

AAII
And to thoroughly confuse you, the retail investors are actually rather fearful: 50% bearish and only 33% bullish. This level of sentiment has corresponded historically with important intermediate stock market bottoms.

ISE Sentiment Index
Last week (November 16th) the ISEE sentiment index fell to 68 - that is, 68 long call options were initiated for every 100 put options. This is not the extreme historical lows but it is low enough to be a strong signal. Perhaps of an upcoming intermediate bottom being carved out from abundant fear and loathing.

Magazine Cover
According to the Economist, the US economy is about to be gobbled up by a recession? sub-prime mortgage and/or credit crisis? the disappearing dollar? I have no idea what the shark is supposed to represent exactly.

But it doesn’t matter since the Fed seems to agree. At least thats what it seems from the newly released minutes of the Oct. 30-31 Fed meeting. The Fed Funds futures market has now built in another 25 basis point cut when the Fed meets next in December.

Hmmm… that sounds remarkably familiar. Where did I read about the Fed cutting rates in the summer before they started slashing? And then again about one last rate cut before the year’s end?

It just rings a bell

The two major groups in the stock market have been and will always continue to be large, well capitalized and well informed “insiders”; and the small, underfunded, emotional, ignorant retail investors and traders.

These two groups engage in a financial dance which invariably concludes in the long term with one group enriching the second. Although they usually don’t take such contrasting positions, at times they can mirror each other.

A good example was in 2000 at the top of the internet bubble. The knowledgeable, “insider” team made up of hedge funds, investment banks, other Wall St. operators and the private equity team sold bits of paper (shares) in exchange for money from the retail crowd.

Right now we are seeing another one of those times. But this time it is the “insider” team that is on a buying spree.

Commitment of Traders
I’ve already mentioned that the commercials were crazy long equity futures contracts and although some time has passed things have not changed. The commercials are long about $38 billion worth of contracts while the small speculators are long their smallest amount since the bottom of the bear market.

Fund flows
According to fund flows data estimates, as the retail investor is fleeing the equity markets and seeking the sanctuary of bond markets and money market funds, the institutional investor is buying with the same intensity. Watch video about half way on the link.

Insider Activity
Corporate executives and other insiders are probably the most knowledgeable about a company’s future and while the market has taken a tumble, they haven’t been spooked. On the contrary, their buying here is only equaled to that seen at the bottom of the bear market. This in contrast to the retail investor who has been buying anything but US equities.

Newsletter Market Timers
The best market timers among the newsletters are wildly bullish, with an equity allocation of 92%. Meanwhile the worst are out of the market completely with a 0% allocation.
Credit: Mark Hulbert in Barron’s