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.

If it is Friday then this is the week’s sentiment round up:

Sentiment Surveys
If you’ve been monitoring the mutual fund flow data, you wouldn’t be surprised to see the AAII continue to show the average US retail investor as decidedly unimpressed and cool about the rising stock market. This week the pessimist camp grew slightly to 41% while the bulls shrank by 9% points to 35%.

The latest Investors Intelligence bulls edged off the half way mark to 48.9% while the bears increased slightly to 24.4%. This is nothing really noteworthy by itself, except to mark the continued 2:1 bull to bear ratio we’ve been seeing for the nth week. So far, the market has not succumbed to this flashing red light and it is anyone’s guess when it will finally decide to do so.

I mentioned the NAAIM Survey of Manager Sentiment as a lesser known sentiment measure at the start of the year. And it is time we updated it to see what it can tell us about the mood of active investment managers in the US:

At the end of September the NAAIM was +86.41 and has since dropped slightly to 68. It is difficult to see in the chart above, but the last time this sentiment measure showed as much bullishness was back in - Yikes! - October 17th 2007 (when it was +86.93). And it was surprisingly, even higher earlier in that year when it reached +90 in January, February and May 2007.

The RBC Consumer Attitudes and Spending by Household (CASH) survey jumped 11.8 points to 51.8 in October - this, after falling to an all time low of 1.6 in February 2009. The monthly RBC Index measures consumer attitudes on the current and future state of local economies, personal finance situations, as well as their savings and confidence to make large investments.

Finally, Consensus which measures futures traders shows them to be 72% bullish. Once again, raising the hairs on your back, that’s the highest level since October 2007.

Option Traders
The puts and calls are flying furiously but there is a definite skew as option traders favor the bullish side of the derivatives. Both the ISE and the CBOE measures of option activity show a continuing crowding on the long side.

The ISE sentiment index (equity only) closed at 221 this Friday, implying that more than twice as many calls were purchased to open a trade as puts. Meanwhile, the CBOE (equity only) put call ratio fell to 0.47 on Tuesday - among the lowest single day ratios for the whole year… so far.

Rydex Traders
But the itchy trigger fingered Rydex traders have suddenly gotten cold feet. Even as the market has recovered smartly from its latest set back, the Rydex Nova/Ursa ratio has fallen as these short term market timers eschew the long side:

Conclusion.
Cross currents in sentiment are completely normal and something that any contrarian has to get used to. However, the current market’s sentiment conditions are especially confusing as it seems that one measure simply contradicts the one before it. When you don’t see an edge, don’t push your luck.

There is a lot of material to cover in this week’s stock market sentiment summary, so let’s get started:

Sentiment Surveys
According to the weekly retail investor AAII survey, 29% of respondents are bullish - a tiny increase from last week. Meanwhile, 47% of respondents expect the market to decline going forward - an increase of 8% points.

More interestingly, the AAII asset allocation to equities continues to increase. The last time we looked at this in early May 2009, it had recovered from the abysmal level of 41% - the lowest on record. Now it is at 57% with most of the increase coming from a reduction in cash holdings which were at one point the highest on record at 45%.

While as a contrarian the ideal situation would be a continued pessimism (low asset allocation to equities), this isn’t really realistic. It is normal for people’s expectations to be recalibrated once the shock of a system wide meltdown recedes. And we also need for an orderly march towards optimism if the market is going to recover. That is the only way that new money will flow into equity markets and by increasing demand, drive up prices. We are far from extremes of 70% allocation that would provide cautionary signs. So it is a good sign that we are seeing growing optimism from this indicator.

ChartCraft’s weekly Investors Intelligence measure of newsletter editor’s sentiment is - oddly enough - split exactly down the middle: 35.6% bears and 35.6% bulls. Although this is rare, the more important thing is that this is a continuation of a short term trend in the increase of those pessimistic about future market prices and a decrease in those optimistic. Not long ago the bulls outnumbered the bears 2:1 but now, they are the same.

The Hulbert Stock Newsletter Sentiment Index, which tracks a small group of newsletters which try to time the market, is 15% points lower now than it was in early June. For those that time the Nasdaq, the mood is even gloomier: 27% points lower today than in June.

When you consider that almost all indexes are now trading slightly above last month’s highest levels, this gives new life to the spring rally. This is because while the recent decline spooked the average market timer enough to reign in their horns, the following sharp rally which made up for those losses did not made them rejoin the bullish camp. This reticence to become optimistic once again in the face of higher prices is bullish from a contrarian viewpoint.

While Wall Street strategists may get paid much more than the average retail investor, their prognostications have, on average, equal dependability - which is to say, not much. Just as the retail investors were fleeing from the bear market by reducing equity allocation and building cash and fixed income levels, the Wall Street strategists were also doing the same. In fact, their lowest level of equity allocation since 1997 coincided with the March 2009 low. And once again, in lockstep with their retail strategists, they’ve upped their equity allocation slightly in response to the higher stock market prices.
Continue reading ‘Sentiment Overview: Week Of July 17th, 2009′

Here’s this week’s walk through the sentimental landscape:

AAII
The retail investors, as measured by the weekly AAII survey are paring their new found bullishness. The bulls are down to 34% while the bears increased to 45% (each going in the opposite direction by 10% points from last week). Although this is an about face, it only takes us to sentiment territories we have occupied since late March.

Investors Intelligence
The newsletter editors on the other hand as sticking to their guns. According to ChartCraft, this week the II bulls are at 40.7% - almost unchanged from last week - while the bears were 29.1% - down slightly from last week.

ISEE Sentiment
Although we closed the week down, and Friday flat, the retail options traders, as measured by the ISE sentiment, were quiet ebullient. They spent the entire week see-sawing up and down then on Friday they bought twice as many calls as puts, putting the ISE sentiment index at an even 200 (equity only).

To get some perspective on this, see last week’s sentiment overview which showed a chart of the ISE index and a short term moving average. All in all, such optimism has easily tripped up the market in the past.

CBOE Put Call Ratio
We see the same nonchalant display from the option traders at the CBOE. The put call ratio (equity only) continues to drip lower, reaching for the uptrending channel that it has occupied for some time:

The 21 day simple moving average has been a good guide for timing the market with this indicator. Whenever it has fallen to similar depths, the market has had either a tough time or fallen precipitously. But, as you’ll notice, the CBOE put call ratio has been behaving rather bizarrely throughout this bear market.

The S&P 500 has managed to sustain an uptrend even as the put call ratio has fallen to levels which previously would have halted it in its tracks. Arguably, the market should have stopped going up sometime in April. Of course I mean that facetiously because I’m not about to tell the market what it should or should not do.

The Grey Beards
I keep track of a few ‘grey beards’ - investors who have lived through several bear and bull markets and have the scars to prove it. The 71 year old Steve Leuthold of Leuthold Weeden is one of them. He called the March bottom almost to the day! Click to watch the Bloomberg video here (from March 4th 2009).

Keep in mind that he runs a short fund aptly named Grizzley Short Fund. But he’s agnostic enough (and brilliant enought) to see opportunity when it presents itself. Since having changed his position, he now is considering adding to his longs - for details see this article (and video) from Bloomberg that I already showed you at news.tradersnarrative.com

The continuous slow motion melting of the volatility index (CBOE’s VIX) has gotten a lot of attention lately. I briefly mentioned it last month when I pointed out that the VIX has shrunk to its lowest in 6 months. Now we are below 30 - which is not really an important milestone, except that it is a nice round number. And that we are now back where we were in September 2008 just around the time that Lehman Bros. blowed up good taking the rest of the market with it.

Here’s a long term chart of the VIX showing the significant support that it broke through to the downside:

While most people with some familiarity with the VIX automatically assume this means there’s a bull market around the corner, the truth is more nuanced. Here’s a zoomed in chart of the VIX showing that while we gapped lower and closed higher for the day, we still closed below 30.

My hunch is that there are two things happening right now. One is the always present movement of the VIX which is normal and derives from the options market. The other is the return to normalcy from an insane period of time. Believe it or not, there was a time that 30 was considered extreme. And yet, here we are approaching it from the other side!

According to Interactive Brokers: This brief analysis highlights the springboard rally for stocks as overly pessimistic conditions fade. As they do, watch for investors to overdo the volatility decline. As we keep noting, we’re still not out of the woods yet. Also, according to IB, there are 2.1 million VIX contracts expiring tomorrow with more than a third being calls (people betting that the VIX would go higher).

As Eddy helpfully pointed out:

Since 1990, when the VIX is below 15 (about 31% of the time), the S&P’s annualized return is 7.8%.
When the VIX is between 15 and 20 (27% of the time), the S&P’s annualized return is 2.8%.
When the VIX is between 20 and 25 (22% of the time), the S&P’s annualized return is -1.5%.
When the VIX is over 25 (20% of the time), the S&P’s annualized return is 11.1%.
To the extent there’s a tipping point, it seems to be a VIX of 13. Above 13, the S&P shows an annualized return of 3.0%, below 13 it jumps to 14.1%. However, 13 is a very low VIX reading; it’s been below 13 about 18% of the time.

Below is an CNBC interview with Carter Worth, chief market technician at Oppenheimer Asset Management. Worth provides some perspective by mentioning that the average level for the VIX since its founding is around 19. Watch the video to see why Worth thinks the VIX’s trend is about to change:

Also, check out Barron’s: Don’t Get Euphoric About a Falling VIX