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′

Let’s face it, this market has been driven by technicals not by any real fundamental health. So what happens when the same folks leave and take their rationale with them, fundamental investors may not be as keen to support the bids.

The recent softening in bids shouldn’t be a surprise. On October 15th the S&P 500 briefly traded 20.81% above its long term moving average. Now, it is only 14% above it. It was back on September 16th that the S&P 500 index first reached the 20% Maginot Line. Between then and now we had 4 other instances where price briefly pierced minutely above the 20% barrier only to be pushed back. Compared to historical precedence, this is part for the course.

As I presented in the detailed historical research report (What Happens This Far Above The 200 Moving Average?), usually when price moves this much away from its long term trend it has been unable to continue at the same pace. That’s what we’re seeing today as the S&P 500 is now below where it was trading on September 16th.

In this short video you can see the headwinds arrayed against the S&P 500. Both by the breaking of the uptrend line from March 2009 and the approaching downtrend line from the top of the bear market (October 2007):

One of the most important sectors, the Philadelphia Banking Index (BKX) has broken this uptrend line. We are also seeing some serious breadth (advance decline) weakness which is never really good but especially bad news while the market is so near a top.

Two institutional money managers have turned negative on the market recently. Jeremy Grantham of GMO Partners and Bill Gross of PIMCO. Click here for details on Grantham’s reasoning and to download his full quarterly report. Gross goes further than Grantham saying: “almost all assets appear to be overvalued on a long-term basis”. You can read his full commentary here.

For those who like to look at fundamental data like the quaint P/E ratio, here is a very long term chart, courtesy of Prof. Shiller:

As you can see, a lot of air was let out of the bubble. But, to mix metaphors, the pendulum didn’t swing back enough. During previous important market lows, the P/E ratio has fallen to much humbler depths. Thanks to the 60% rally from the March lows, we are once again back above the long term average. Which is unsettling, especially when you remember that Shiller uses a 10 year smoothing of the earnings data to iron out short term noise.

October’s P/E earnings, according to Shiller’s methodology is about 20 - well above the long term historical average of 16. Normally, a P/E ratio of 20 corresponds to economic expansion in its 5th year, not a major recession like the one we’re experiencing now. So understandably, Prof. Shiller is skeptical of the recovery in the equity market making the inevitable comparison to the aftermath of the 1929 crash and saying that “it can’t be trusted to continue”.

And turning our attention momentarily to the options markets, the equity only ISE sentiment index came in today at 191. Which means that while the equity market had a negative day with red all over the monitor, retail option traders tenaciously clung to hope and bought almost twice as many calls.

And if all that wasn’t spooky enough for you, to coincide with Halloween this year we have the 80th anniversary of the Great Crash of 1929. Boo!

No, there is no free lunch. But for my US readers, there is a free trading magazine subscription in their future.. For a limited time, you can get a complimentary subscription to SFO magazine (Stocks, Futures, and Options).

It takes less than a minute to sign up and you need to provide some basic information. But as I mentioned, you need to be a resident of the US (because you need to provide a US address). Enjoy!

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′

The following is a run down of this past week’s sentiment data:

Sentiment Surveys
Let’s start by looking over some of the well known sentiment surveys:

The retail investors sentiment as measured by the AAII survey was equally balanced with bears and bulls both at 39% - and the rest undecided. To arrive at the tie, the bullish camp shrank by 9% points and the bears increased minimally (2% points).

ChartCraft’s Investors Intelligence continued to grow more bullish this week with 47.7% bulls and 23.3% bears (with the rest neutral). That’s more than twice as many bulls as bears! The last time we had this much optimism from this measure of newsletter editors’ sentiment was in December 2007. Interestingly enough, the S&P 500 back then was trying to get above its 200 day moving average - it didn’t succeed for too many days.

The Hulbert Stock Newsletter Sentiment Index (HSNSI) confirms the II data showing that the average equity exposure has increased by 60% points since early March 2009. Although some shift in sentiment is normal at the end of a bear market, this is double the average increase in the first 3 months of previous bull markets.

Rydex Ratio
We haven’t looked at the fast money traders in Rydex mutual funds. They have recovered from the March extremes but we are a ways yet from reaching the other side of the graph:

Option Traders

The CBOE put call ratio (equity only) fell to 0.55 on Thursday. That is a level which, while not being an extreme low, is low enough to show considerable confidence in the stock market. In effect, there were almost twice as many calls traded as puts (twice as many bets that the market would go up, as opposed to down). Other than this small blip, the larger picture hasn’t changed much since the last chart I featured in the sentiment overview last month.

The ISEE Sentiment data was even more lukewarm, offering no real clues from a contrarian perspective. The ISE equity only call put ratio was 191 which is relatively high. But we’ve seen a few isolated instances at this level before and it hasn’t been enough to stop prices from rising.

Hedge Funds
The latest data from Hedge Fund Research shows the average hedge fund 45% net long (as of May 19th 2009). That’s up from 33% earlier in the year but not as long as one year ago. The good news for the bulls is that there is still a lot of dry powder in hedge-land waiting to be deployed (especially if the market keeps going up and forces hedge fund traders to get off the fence). The bad news is that the so called ’smart money’ hasn’t really believed in this rally… yet.

Here’s this week’s sentiment landscape:

AAII
The retail investment survey carried out by the AAII is almost unchanged since last week with 44% bulls and 35% bears.

Investors Intelligence
ChartCraft’s survey of newsletter editors’ sentiment showed 41% bulls and 33.7% bears. Similar to the AAII survey, very little changed from last week. If anything, the undecided’s shrank.

Options Sentiment
The CBOE (equity only) put call ratio closed the week, very close to where it started it, at 0.63. Looking at a short term moving average, we’ve reached a level that has previously corresponded to market headwinds. The CBOE put call ratio has a slight upward slope, so the ‘low’ keeps shuffling higher. We are now back to levels which we last saw towards the end of March 2009 - of course, that didn’t stop the market from marching higher.

While the S&P 500 has been in a downtrend for the whole week, hitting a high of 920 and then closing at 883, you wouldn’t know that if you looked at the ISE Sentiment Index. Retail option traders, as measured by the ISE. On Monday and Thursday they bought almost twice as many calls as puts. That’s befuddling so let’s step back.

This chart shows the equity only ISE Sentiment index from January 2008 till now. Looking at the 10 day moving average of the ISE Sentiment, we can see that it is now at levels that correspond to past market tops :

Since 2008, whenever the ISE ratio reached 180 or so, stock market prices fell. The first case was in early January 2008 when the ratio reached 183. The second was May 2008 (174), which was the top of the first real bear market rally. The third was in the final days of 2008 when the Santa Claus rally petered out (173.5). And that brings us to today with the 10 day moving average of the equity only ISE sentiment ratio at 180.

Having said that, the ISE Sentiment’s 10 day moving average has gone much higher. On July and October 2007 it was 245 and 229. But the psychological tone of the market has changed from that time and it is more useful to look at the behavior of this indicator during the bear market.

Finally, notice that this options sentiment measure totally missed the March 2009 low - no indicator is perfect. This is why I look at the weight of the evidence rather than singling out any specific metric at any point in time.

Bloomberg Professional Global Confidence Survey
I mentioned this relatively new sentiment a few days ago at news.tradersnarrative.com. Since it was only started in November 2007, we have scant information for comparison but according to the participants, the global economy is on the mend. The BPGC climbed to 38.72 in May from 21.2 in April. That’s the biggest increase since the start of the survey. But because it is still below 50, it means that they view the economy as still contracting (but just not as much).

Also, for the first time since the start of the survey, investors are predicting that the Standard & Poor’s 500 Index will climb higher.

The respondents were most optimistic about Brazil and Mexico - shrugging off any lingering swine flu panic. And less enthusiastic about European market forecasting that France’s CAC 40, Germany’s DAX, the IBEX 35 in Spain and the U.K.’s FTSE 100 will decline.

Brazilian confidence climbed 11 percent to 62.6 - its highest level since June. As I mentioned a few days ago the Bovespa has been on a rampage posting the biggest monthly gain in four years in April 2009. The obvious explanation is that investors are betting lower interest rates and firming in commodity prices will propel their market higher.