Trader’s Narrative

The Present Situation Index of the Consumer Confidence survey from the Conference Board fell to 29.4:

That’s lower than the 2002 bear market bottom. Lower than the confidence level in 1991. Lower than the early 1980’s. Even slightly lower than the darkest days of the 1970’s bear market.

As far as I can tell, the current reading is the lowest that this survey has seen since it was started in the 1960’s!

The Conference Board surveys 5000 US households and their answers to questions about their employment, spending and

From a contrarian perspective this is good news. And this is just another in a long line of extreme pessimism from the average consumer and investor in the US. But from another perspective we need to see at least the start of a change in the doom and gloom before things get better.

If you have a really long term view and don’t particularly care about further declines in the short term, then this is a good signal. But if you want to avoid such potential losses then you have to give up trying to anticipate the market’s exact inflection point and wait for confirmation by giving up some gains to the upside.

Here is the sentiment overview for the first week of 2009:

ISE Sentiment
On Monday I mentioned that the option traders on the ISE were shockingly optimistic, going long more than twice the number of calls than puts. Things quickly calmed down and the ISE sentiment ratio fell closer to parity at 123.

On the plus side, this resolved the “quietness” that had fallen over this options market. The range contraction of the ISE is no more. But to be honest, I was imagining it being broken to the other side.

The short term moving average (10 day) of the ISE sentiment ratio continues to be too high - reflecting a worryingly lopsided demand for call options by retail option traders.

CBOE Put Call Ratio
The traditional ratio measuring option activity spiked to 1.07 on January 7th and then fell again. I’m not sure if we can attribute too much meaning to this. Especially when the over all picture of the CBOE put call ratio is still one of optimism.

AAII Sentiment
The American Association of Individual Investors released their sentiment data for this week: bulls jumped sharply to 48.70% (from only 24% last week) and bears were only 35.06% of respondents (compared to 54.67% from last week).

Clearly we are seeing the average American retail investor jump on the bandwagon of hope.

Investor’s Intelligence
According to Chart Craft, this week’s Investor’s Intelligence sentiment survey shows 41.8% bulls and 34.1% bears.

We’ve watched a continuous increase in bullish sentiment from this indicator for the past few weeks. Specifically, this is a slight increase since the last week of 2008 when both bears and bulls were both equal at 38.5%.

As well, the last time we had more bulls than bears was back in August 2008 when the S&P 500 was trading at 1300. It was a momentary blip of exuberance but we all know what happened after.

You can see this on the chart to the left.

Hulbert Newsletter Sentiment
The Hulbert Stock Newsletter Sentiment Index (HSNSI) measures the optimism or pessimism of market timing newsletters. The “Santa Claus” rally added to the gains of the S&P 500 since November’s low, taking us 20% higher and technically into a new bull market.

According to Mark Hulbert, the HSNSI was at -18.9% when the S&P 500 hit its November 2008 low. This means that the average market timing newsletter was advising their clients to be short the market with that portion of their portfolio. But as of this week, they are now suggesting a +43.5% allocation (long).

Although we need people to get bullish (eventually), this is just way too much too fast. The ideal situation from a contrarian viewpoint is to see reluctance or disbelief after a rally. That’s not what we are seeing (from this metric at least).

Sentiment Surveys
According to Investor’s Intelligence newsletter publishers are as gloomy as they have ever been. This week’s sentiment bearish sentiment was 54.4% with bullish newsletter editors unchanged. While slightly more than half may not seem like much, you have to understand that like most media outlets, newsletters have a positivity bias that skews readings. But keep in mind that the II measure is not completely quantitative.

The American Association of Individual Investor’s (AAII) sentiment survey in contrast continues to show that retail investors in the US have suddenly become very bold. Similar to last week’s sentiment the optimists and pessimists are both 38.74%. This apathy or lack of fear is strange and more than a little unnerving.

Volatility
Volatility continued to climb to the astonishment of everyone (first and foremost yours truly). The CBOE VIX index spiked to 89.3 and settled down to “only” 79.1 - quick someone give me a synonym for un-fraking-believable. Looking at the VIX futures market, the “smart” money, or commercial hedgers are carrying the largest long position they have ever been since the contract started. While the retail traders are taking the other side of the trade.

Options
The options market yawned as usual. I prefer the CBOE equity only put call ratio because it filters out the noise. Although it rose, it didn’t even manage to reach 1.0 - it should easily be above 1.5 considering what we are going through. I tried to explain this crazy options market. But I’m not sure if I even convinced myself. This, like the majority of what is going on, is a head scratcher.

Fund Flows
As you can imagine, mutual funds have been hemorrhaging assets as people either sell to stuff cash under the mattress or take the slightly less safe road and buy money market funds. But preliminary numbers for the most recent fund flows shows a slight inflow. Again, this is puzzling. From a contrarian point of view, the ideal condition would be a continued outflow trend, even if the market rallied or stabilized - which it hasn’t really done.

What I’m still waiting for is the tsunami of hedge funds redemptions. Usually hedge funds have a lock up period to give the manager some breathing room. The more exclusive the hedge fund, the longer the lockup but usually it is 2-3 months.

Lowry’s 90-90 vs. Selling Pressure
As the VIX indicates this is an unbelievably volatile market. We’ve had so many 90-90 days (or very close calls) that my head is spinning. On Friday 84% of volume on the NYSE was negative. On Tuesday (October 21st) we saw almost the opposite with 87% flowing to stocks trading up.

Paul Desmond’s research at Lowry’s into the efficacy of 90-90 days has permeated the trading and investing world so much that I fear it may jump the shark. But assuming that it hasn’t already, there is more to the market than just watching for these important days. Lowry’s itself calculates two aggregate indicators for the market’s health: buying and selling pressure. Right now selling pressure has the upper hand (after jumping to an extreme level). Until it subsides and buying pressure takes over, the market isn’t going to go up.

As mentioned yesterday, the market tell everyone was watching today was the Lehman Bros. CDS auction. The results were not unexpected with the bidding coming in at just under 10 cents on the dollar.

The market continues to slide lower with the VIX volatility index reaching an eye-popping ~72%+

As I hinted yesterday, LIBOR may have topped because today it is down very slightly (at least it didn’t go up!). The overnight LIBOR rate is down to 2.47% from Thursday’s 5.09% - the chart below is for 3 month LIBOR. But the TED spread continues to creep up. What makes this wealth erosion devastating is that we are stair-stepping down in the stock market, rather than free-falling in full crash mode.

Something that has been pushed off the radar by the financial crisis is the dismal state of both Ford (F) and General Motors (GM). There was a time when Wall St. looked at GM as a barometer of the economic health of the US. The stock is now trading at single digit levels it was during the 1950’s when the Dow was trading at the 200 level.

Iceland, as you’ve heard, is now bankrupt and is listed on eBay. Their currency is worthless as banks refuse to even touch it.

Headlines are shouting: “The End of American Capitalism” and worse. Rothschild is purported to have said:

“It requires a great deal of boldness, and a great deal of caution, to make a great fortune.”

The trick is to be bold when everyone else is fearful and to be fearful when everyone else is bold. If you can do that, then come back and teach me.

If nothing else, all this will make for a great story for your grandchildren, in some Mad Max distopian future.

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’