Trader’s Narrative

Here is the sentiment wrap-up for a week that saw new yearly highs:

Dow 10,000
Yes, the Dow Jones reached and surpassed the magically round number 10,000. But in case you were too busy to count, this is for the 26th time it has done so in the past 10 years. So that means we’ve had about 10 years of zero returns (excluding dividends and inflation). Those specialty party hats the NYSE hands out are well worn by now and no one really knows what we’re supposed to be celebrating.

Sentiment Surveys
Turning out attention to the AAII weekly sentiment survey, we find a large jump in optimism among retail US investors. This week 47% are bullish - a jump of 12% points from last week. In contrast there are 34% bears (a drop of 7% points). Usually this survey gets my attention anytime a particular camp has majority. We’re not there yet, but this is mighty close.

While you will most likely interpret this lopsided survey result to be contrarian bearish, keep in mind that the previous time we saw the bullish ratio this high was a few months ago in July 2009. As the chart shows, the S&P 500 index shrugged off any suggestions of ‘too much optimism’ and barreled ahead gaining 150 points. If I were relying on just the AAII survey, ideally I’d like to wait for the bulls to get to 50% or more before being confident about it tripping up the market.

Investors Intelligence
While the AAII bulls took the reins this week, the weekly survey from ChartCraft measuring the stock newsletter editors sentiment has been dominated by the bulls for a few months now. This week was no exception as the Investors Intelligence indicator came in with 47.2% bulls and only 26.4% bears. So this isn’t all that helpful because while II has been stuck showing about twice as many bulls as bears, the market has continued to rise.

National Federation of Independent Business
The monthly NFIB survey results show September inched ahead at 88.8 - which is pretty unimpressive since it isn’t even higher than the results in May (88.9). As well, 6 of the 10 sub-components were either down or flat suggesting that the tiny improvement came from a narrow contribution.

The details of the NFIB survey show the huge disconnect between Wall St. which has enjoyed a 60% rally and an attitude of ‘back to business as usual’ (with bigger than ever bonuses) and Main St. which is still struggling with a very weak economy. Small US businesses are not ready to build up inventories, nor are they planning on expanding capex spending, nor are they hiring, nor are they expecting credit conditions to ease. Small business in America is referred to as the engine of the economy but it has been neglected while ‘too big to fail’ banks and investment houses become even bigger and received billions of dollars from the government.

Option Traders
The sentiment in the option pits continues to be very very bullish. While some of the penchant for calls can be attributed to the stock replacement strategy, I don’t think that explains enough to discount the alarming extent of the skew.

The ISE sentiment index (equity only) which exclusively measures retail option traders opening transactions spent 4 days out of the 5 trading days in this past week above 200. That was enough to take the 10 day moving average of the equity only call put ratio to 200.8 which is the highest since November 2007. For a chart, see the sentiment overview at the start of the month.

The CBOE (equity only) put call ratio is also showing a similar pattern of excessive call buying. Its 10 day simple moving average is 0.52 which is among the lowest levels for many years. In the following chart, you can see how the S&P 500 has responded when we’ve seen this much optimism:

This is by no means an exhaustive or quantitative study but it does show that while the equity markets can rise a bit in the face of such bullish option sentiment, sooner or later, it catches up with it. Either the market goes sideways or corrects sharply. Hmm… that sounds familiar.

Volatility
As an alert reader pointed out, the CBOE volatility index (VIX) is now scraping a bottom not seen since September 2008. In case you’ve blocked out that painful memory, that was just before the catastrophic waterfall decline which took the S&P 500 index down to a 6 handle. But from all the historical studies that I’ve seen, a low VIX doesn’t really mean anything, not in the way that a spike high denotes a panic bottom for equities. After going through some absolutely insane volatility we are once again returning to historically normal ranges so I don’t think there’s much edge here.

IPO Pipeline
The private equity groups are getting more and more of their holdings gussied up for public offerings. If you know how shrewd an investor these institutions are, you do not want to be on the other side of their average trade. After all, timing the market is pretty much all they do. They fund or take unloved companies private and then when the public sentiment is ripe, they sell them back again for a higher price.

In the following weeks, Fortress, KKR, Blackstone and Bain Capital will be bringing a half a dozen IPOs online. Unlike the traditional IPO where a company raises money for expansion, these are exits where the firms that took an opportunistic stake want to get their money back with a healthy return. Usually a healthy IPO market is a sign of a healthy equity market and only when it become excessive should we take a contrarian stance. But now, I’m watching the number of IPOs and the welcome they receive in the market as a gauge of the mood out there.

Below is this past week’s summary of sentiment data:

AAII
According to the American Association of Individual Investors, the average retail investor in the US is down right giddy. This week the bears declined by 2% points to number just 33%. The bulls meanwhile managed to eke out a tiny 1% point increase from last week to reach 51%. Anytime we see the magical 50% mark in either camp, I take special notice.

To find a higher level of bullishness, we have to go back to May 2008. For the week of early May 2008, the AAII survey showed 53% bullishness. In that sentiment overview, I wrote:

There is no way we can discount or ignore this. Such a high level of bullishness is downright frightening - from a contrarian point of view.

When I wrote the above, the S&P 500 was trading around 1410. In a few weeks it had managed to peek over 1420. But that was it. If you were looking or a sign that the market rally had petered out, you would have a hard time finding a better one. By July 2008 it had fallen to 1200 and by November to 750. As well, this level of bullishness is extra noteworthy because it was at this level of optimism on October 2007 that the stock market topped and entered into its current bear market.

In the same way, I think today, if this single data point doesn’t make you run for the door, it should at least be making you eye the exits warily. While the retail investor has been building back their confidence throughout this rally, their increasing bullishness will inevitably reach a climax point. Here’s a chart showing the last 3 times that the AAII sentiment was so optimistically lopsided that at least 50% were bullish:

Continue reading ‘Sentiment Overview: Week Of August 14th, 2009′

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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The National Federation of Independent Business (NFIB) Small Business Optimism Index fell 2.6 points to 85.2 in December 2008:

This is an aggregate measure of 10 indicators: outlook for expansion, earnings, sales, and hiring. Amazingly, the net percentage of small business owners planning to hire is -6%. That scrapes the bottom of the barrel and is analogous to the recession we saw back in the 1970’s (not shown on graph).

Small businesses are often been touted as the engine of the US economy. From this survey it is obvious that the engine is flat out junked. These numbers are as bad as we’ve ever seen them in modern history.

The NFIB survey complements the other sentiment readings we’ve been getting from other sources such as the Conference Board Consumer Confidence and the State Street Investor Confidence Index.

You can get more information and download the full report at the NFIB site.

Everything seemed to be going alright and then GE came along and whacked the markets with their largest earnings miss in at least three years.

Any way you cut it, Friday was a horrible day (for the bulls). There were 2440 issues declining on the NYSE (out of 3211) and on the Nasdaq, 2,290 fell out of 3,037 traded. Advancing volume was dwarfed by declining volume - 9:1 on the NYSE and 6:1 on the Nasdaq.

Of course, I don’t think that GE is the real cause of the market’s fall but it is a comfortable excuse for most. I outlined my hesitation that the market was approaching resistance levels and that the odd lot short sales were too high to give me reason to believe that the rally would continue.

Surveys
According to Investor’s Intelligence, newsletter editors are for the most part unchanged in their view of the market. Meanwhile, the AAII sentiment has now recovered that it is slowly approaching just a tad too much optimism: 46% bullish, 37% bearish.

The same can more or less be said for the other sentiment measures: LowRisk, Consensus, and MarketVane, so I won’t bore you with their mundane details.

Put Call Ratios
The decline wasn’t enough to push the CBOE put call ratio to parity. It climbed to just barely below 0.90 - below levels which we would associate with panic:

Before Friday’s thrashing, the small option traders as measured by the proprietary ROBO ratio had actually increased their pessimism despite the market’s recent rise. I always take notice whenever sentiment goes in the opposite direction of the market it is tracking. But again, this was before GE threw a monkey wrench into the works.

NFIB Sentiment
The National Federation of Independent Business (NFIB) is reporting that small business sentiment in the US is at an historic low. They have collected information from their small business members for more than twenty years and this most recent response is the gloomiest assessment of business outlook ever.

So it seems that the horrendous consumer sentiment has company.

As you would no doubt surmise, such pessimism is actually good for the market. Whenever we have an excessive level of doom and gloom, the worst is already behind us. I’m referring to the stock market here because while there may be real pressure on consumers and small businesses, the stock market is a forward discounting mechanism.

And because it looks forward while other indicators measure the past or present, it can seem to be paradoxically the opposite of the real economy.