Trader’s Narrative

Here’s the sentiment summary for this week’s trading:

Sentiment Surveys
According to the sentiment surveys, an alarming number of investors and market timers have returned to the long side. The weekly AAII retail investor sentiment survey shows 48% bulls (an increase of 8% points) and 37% bears (a decrease of 12% points). We haven’t seen this many bulls in the AAII survey since the first week of the year. As I’m sure you’ll recall, that was not a happy time for putting new money to work on the long side.

According to ChartCraft, the weekly Investors Intelligence newsletter sentiment survey shows 42.5% bulls and 25.3% bears. The S&P 500 ended the week 21 points higher (or 2.2%) so the market hasn’t really done anything to deserve such hope or devotion.

Barclays Capital Sentiment Survey
Barclays Capital said that only 17.5% of the 605 respondents to its quarterly sentiment survey believe that ‘risky assets’ have more room to rise. Those taking part in the survey were central banks, asset managers and hedge funds. The majority believe that the world economy will experience either a protracted slowdown or if it is in recovery now, it will falter once more (a “W” shaped recovery). Asked whether the spring rally was just a “bear market rally”, 60% agreed - indicating that there is still a lot of dry powder out there.

NAAIM
Along with most sentiment measures the NAAIM trend survey of managers has recovered since the spring lows. For more information on the metric check out: NAAIM Sentiment Survey.

Market Froth
We’ve seen a lightning fast return of speculative trading to the stock market. You can see it in the volume of ‘garbage’ stocks (trading below $5/share) and in the general willingness of most people to shrug off the dark foreboding sense they harbored just a few months ago that the end was nigh.

There is also mounting evidence from the Rydex fund flows that the trigger happy traders that use these securities to time the market are piling into the long side. This is the case for both leveraged and normal Rydex funds and has in the past marked either significant market tops or the start of a plateau. In either case, when there is so much lopsided optimism in Rydex mutual funds, it is a flashing red light for those long the market.

Magazine Cover
I have a gut feeling that this week’s Economist magazine cover should be framed somewhere for posterity. It is a graphic showing a Tyrannosaurus Rex made up of car parts, leaking oil (as if bleeding).

I can’t help but wonder, if by the time a magazine puts up something like this, have the auto industry sector reached a nadir?

And I’m not thinking that because the image is hyperbole but because it is a creative representation of the unvarnished truth. I’d prefer if it was on Newsweek or Time but we’ll see. I think this Economist cover is one we’ll come back to years from now.

The US dollar has fallen to its long term support. And I do mean long term (see chart below).

Since the early 1990’s it has approached this level 5 other times. In all but one case, it has reacted by bouncing off support.

The exception was in 1992 when for a short time the index breached the 80 “line in the sand”. But it then bounced above and went on to rise much higher. A classic bear trap.

Right now we are still above 80. History is our guide but anything can happen in the markets. We could bounce higher, we could go lower or we could just sit here at these levels for a while.

What I’m going to be watching is sentiment. Keep a watchful eye for negative articles or even better headlines and cover stories about the dollar. Or about the debt held by China.

The best contrarian signal the longs could hope for would be a very negative cover story in a general interest magazine like Time or Newsweek. Maybe Business Week will pull through as it has so many times.

Since the dollar and gold are intricately linked, any bounce for the dollar here will be the final nail in the coffin for the gold sector. But then again, that massive consolidation in the Phili Gold index (HUI) could turn out to be a bull flag. I doubt it. But who knows.

Click to Enlarge Graph: