Trader’s Narrative

What a week. This will go down in history so make sure you pause and take note. Wall Street just had its worst week in history. So how is the sentiment landscape?

Sentiment Surveys
As I hinted earlier in the week, we saw some downright gloomy sentiment from all the usual surveys. Investor’s Intelligence, which monitors newsletter writers sentiment came in at only 25.3% bullish and a whopping 53% bearish. This is the lowest number of bulls since 1994!

Of the AAII weekly sentiment respondents, 60.8% believe we are in for more downside while only 31.5% are bullish (the remaining few are ambivalent). This is the second highest level of bearishness from the AAII sentiment survey. The last time was on October 1990. For a graph see: AAII Sentiment.

Anecdotal
I’m hearing a lot of fear and loathing from all corners. Trader Mike’s blog is getting a lot of traffic coming in from people googling “how to short” which is always a sign of capitulation of some sort. Regular folks are disgusted with the market and fearful of their retirement security. You can see comedians and commentators on TV talking about the stock market every night. Steve Cohen, the legendary hedge fund virtuoso, apparently threw in the towel and told his whole trading floor: “You’re all idiots. We’re going to cash. I’ll see you in January.”

Rydex Market Timers
Before the rise of the ETF phenomena, the Rydex funds were the only vehicle which allowed market timers to jump in and out of the market, and to even take short positions (by buying a fund). Although ETFs have definitely eroded the popularity of Rydex compared to when it was the only game in town, they still have a very strong following.

Right now these market timers have skewed the asset ratio to a degree that we haven’t seen since the bottom of the bear market in 2002 and early 2003. Of the the total assets held in the Rydex S&P 500 Index funds, only 15% are long.

Hulbert Newsletter Sentiment
At the start of the week the Hulbert Stock Newsletter Sentiment Index (HSNSI) was -36.1%. Meaning that the average short term market timing stock newsletter was suggesting to their readers that they allocate that percentage of their portfolios as a short position. Going by absolute numbers, that is a very low reading.

But just a few months ago in July, the HSNSI was even lower at -42.9%, when the market was trading at a much higher price than now. To put both in perspective, in the aftermath of the September 11th terrorist attacks on the WTC, the HSNSI dropped to -13%. The lowest it got in the ensuing bear market was in July 2002 -15.14% and then a bit lower, -19.2% on March 10th, 2003.

Option Markets
I’m still puzzled by the way the options market has been acting because I expected it to show much more fear than it has. For example, the CBOE put call ratio (equity only) hasn’t even taken out the highs we saw in September (1.18), never mind those of March 2008 (1.35). The ISEE sentiment ratio also continues to show a total disregard for put options from retail traders. With the exception of Tuesday which saw it drop slightly below par, the ratio has shown that retail traders are actually opening more call than put positions!

Volatility
Are you sitting down? This week we saw implied volatility levels which eclipsed the 1987 Black Monday crash. The CBOE volatility index wasn’t trading or calculated back then, obviously. But it is “reconstituted” as if it were. The old method took volatility (VXO) to 86% (intraday high of 103%) . The new method (VIX) to 66% (high of 77%) and for the Nasdaq (VXN) 71.6& (intra day high 82.4%). It’s a good thing we are no longer using paper for charting or we would have to glue on a top piece to the right side edge of the graphing sheet.

Contra Hour Stand
The bulls made a brave stand at 3pm, otherwise known as “contra hour”. But in the end they failed to close above or even break even. Monday is round two. Lets see what the G7 meeting can accomplish.

Headline & Magazine Covers
You don’t have to look far to find incredibly bombastic headlines. Some would say they fit the times. Others that in hindsight they will be another sign of contrarian opinion. Here are two from the Economist magazine (a favourite of Sarah Palin, along with Pravda, the Witchita Gazette and everything else printed since and by Gutenberg):

What an inauspicious anniversary. It is a year since the Dow closed at its all time high - it is now trading down about 35% from that level. While I don’t think we are going to go straight up if things do stabilize, there is enough shrill panic out there to make me think that we should be close to a floor. If we aren’t, then all bets are off and I suggest we all flee to the hills. This isn’t based on mere “gut feeling” but on metrics and indicators that have been faithful guides historically.

So here are some observations:

Global Meltdown
There is enough pain for every single market out there. Forget banning short selling, Iceland outright suspended trading altogether. Indonesia halted trading after a 10% plunge. Russia has seen an utter collapse of their market. Same thing with China’s equity bubble. England has taken equity stakes in financial institutions while other European countries struggle to find a solution. There is a blanket of fear and panic covering the world to a degree that we haven’t seen in a very long time.

Credit Squeeze Easing
The first hints that we could finally be seeing a loosening up of the tight credit markets are here. The spread between the rate for the 2 year interest rate swaps and Treasury yields seems to have formed a double top at 167 on September 29th and October 2nd 2008. At its top, the spread was the widest since data has been collected (going back to 1988). This is a signal of easing for the LIBOR rate but the bad news is that LIBOR and TED spread haven’t responded by falling yet. But this may be the first inkling that they are about to.

Sheer Disgust & Panic
Finally, we can say that there is extremely negative sentiment out there. Both from everyday investors and traders, to newsletter editors. The option metrics are still not “cooperating” by showing extreme put buying. Which is something that I’ve mentioned before. It is still very puzzling to me. But the other traditional measures of sentiment show that the vast majority have thrown in the towel and believe that we will see further declines. From a contrarian point of view, this is a good thing. I’ll go into more detail in tomorrow’s sentiment overview.

How Bad Is It?
Things are so bad that, of the 500 stocks in the S&P 500 Index, only 6 closed trading yesterday above their 50 day moving average. And only 4.2% are trading above their long term, 200 day moving average. For the Dow, all 30 stocks are trading below both of the moving averages.
Continue reading ‘If We Aren’t Near A Bottom, Find A Cave & Buy Guns’

Here’s a review of the previous post on the energy sector:

On September 18th, 2008 I wrote that the energy sector presents a bounce opportunity. As the chart of the S&P Energy Select Sector SPDR ETF (XLE) shows, the bounce was a feeble one which failed within a few days:

But the rational for it remains. The bullish percent index for the energy sector is now the lowest for any sector in the market. The only other sector close to scraping the bottom is the industrials at 3.57%.

What is very strange is seeing the energy sector and the transports in alignment. I mentioned the oversold transportation sector earlier this morning. So what we may end up seeing is the strange case where both of them rally together.

Of course, sectors don’t just rally because they are oversold. Although it is rare, they can and have gotten down to zero. We are approaching DEFCON 2 - if the sentiment overview is anything to go by. And although it sounds absolutely crazy, now is not the time to be selling but rather coming up with a game plan to go long.

The days ahead will demonstrate for traders why being disciplined in respecting stop-losses is more valuable than having the conviction behind a position.

Monday’s free falling market finally brought us some indication of real fear in the market. The indicator that got many talking was the S&P 500 Index volatility index (VIX) being pushed higher than what we saw at the last financial crisis in 1998 (when a few PhD’s from Chicago almost took down the world economy with a little hedge fund called LTCM).

I wanted to take a closer look to see that spike in its proper context. So here is a long term chart of the VIX:
Continue reading ‘The Heartbeat Of The Stock Market Goes Thump’

There has been so much happening that an important sentiment indicator which I usually watch for slipped through the cracks and wasn’t mentioned in the sentiment overview for last week:

And BusinessWeek’s cover asks: Is It Safe Yet?
With the main article inside having a very bloodied bull staggering.