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.

The last time I touched on the odd lot data, it was in neutral territory. But in only a week, it has spiked to an extreme which has historically been very bullish.

Odd lots are transactions in the stock market which are for less than 100 shares. Since this size of transaction is characterized by retail and small traders or investors who are uninformed about the market, it is considered a contrarian indicator. So the more odd lot purchases are made, the more we would expect the market to be topping and the less purchases, the more probability of a meaningful bottom in stock prices.

We can actually gauge the involvement of retail (or “dumb money”) participants in the market by looking at not only odd lot purchases but also odd lot short sales. They should present mirror opposites of each other and usually do.

Odd lot indicators are very fast moving though, so we are looking for a short term bounce here. They are not indicative of a intermediate or long term bottom, unless they come in a herd (rather than a single spike).

That’s what happened recently. In late February to mid March 2007 the odd lot purchases spiked 5 times to bullish extremes. The amateur investors and traders wanted no part of this market (on the long side). No wonder then that we had a significant market bottom form.

The same situation played out in the odd lot short sales where during the same time period there were 4 spikes into extreme bullish levels. Amateurs were falling over themselves trying to short the market (profit from a fall in prices).

Right now though, we have just had one penetration from both odd lot purchases and odd lot short sales into bullish territory. To me that is commensurate with a kick higher going forward - we already saw the beginning of a rally from today’s strong close when the market ended at the day’s high.

Unless we see several spikes in odd lot data, I would only look for a short term but lively rally. Stay tuned for more spikes! And if you know any amateurs out there, inquire politely whether they are buying or selling.

And when they ask why you ask, be polite and say, “Oh, just making conversation.”