Trader’s Narrative

The market correction that we’d been waiting for has finally started in earnest so let’s take a look at the sentiment data for this week:

AAII Survey
This week’s survey of US retail sentiment by the Association of American Individual Investors came in at 34% bullish (a drop of 7% points from last week) and an increase of bears to 42% (a 6% point increase). While the increased fear is normal after the kind of week we had, the ratio of the two remains neutral. Had the response been either muted or exaggerated, it would have been more interesting. At this point, it doesn’t really offer any edge.

Investors Intelligence
The latest Investors Intelligence poll from ChartCraft showed the bull share fall a smidgen to at 48.3%; the bear share also fell a hair to 22.5%. Only 29.2% believe a correction is due. The ratio of the bulls to bears is 2.15 - higher than it has been for months. It must be noted, though, that the survey was compiled on Tuesday before the losses later in the week. Next week’s survey will reflect the full decline.

Daily Sentiment Index
The Daily Sentiment Index remains in rarefied territory. The high levels we find the current DSI is extremely rare. In the 22 year history of this metric the DSI has been 87% or higher, only five times:

Continue reading ‘Sentiment Overview: Week Of October 30th, 2009′

Here is this weeks summary of sentiment data for the stock market:

The weekly AAII measure of sentiment continues to reflect a repentant US retail investor. This week the bulls were unchanged at 34% while the bears increased 9% points to 49%. This is a very abrupt change as it was just 4 weeks ago (Sentiment Overview: Week Of July 31st, 2009) that we had the mirror opposite with 48% bulls and 31% bears. And it was only 2 weeks ago when we saw 51% bulls! This is especially meaningful as the market is actually trading higher

Meanwhile, the Investors Intelligence Advisors Index - a metric of the mood of stock market newsletter editors - is finally showing extreme levels of bullishness. This week’s results pushed the bulls slightly upwards to 51.5% while at the same time reducing the bears to just 19.8%. That widened the gap between the two camps to almost 32% points or put another way, we now have almost 3 optimistic editors for every gloomy one.

So it took the II a few weeks to arrive at the +50% levels of bullishness that we saw from the AAII earlier this month. But while the AAII’s recent lopsided sentiment corresponded to the swing top in May 2008, the discrepancy in the II is even more ominous.

The last time we had less than 20% of the stock market advisors bearish was in October 2007 - the start of the bear market. While the percentage points between the two camps isn’t as wide as in October 2007 (40% points), it is 31.7% points - close enough to merit caution for the bulls.

Right now, looking at these two popular sentiment metrics can be confusing. Either one is ahead of the other or they are both wrong. Fortunately there are many other indicators we will take a look at after the jump.
Continue reading ‘Sentiment Overview: Week Of August 28th, 2009′

Here is this week’s sentiment round-up:

The AAII weekly sentiment survey shows that the consensus reversed suddenly from the giddily bullish extreme that we saw last week. The bulls fell to 37%, a decline of 17% points. And the bears increased to 40% coming to an almost perfect equilibrium.

While this is a dramatic decrease in their level of optimism, I’m still cautious. The last time we had the same level of bullishness in the AAII survey was in early May 2008. And as I mentioned during last week’s sentiment overview, the stock market didn’t roll over immediately in response. The S&P 500 actually climbed slightly higher in the following weeks. So just because the market has overtaken last week’s highs does not absolve it from a potentially mortal weakness.

The average exposure recommended by stock newsletter editors (as measured by the Hulbert Stock Newsletter Sentiment Index) fell to 30.3% - that’s a sharp decline of 17% points from just 7 days ago. From a contrarian point of view, if the level of bearishness continues to rise even as the stock market rises, then it would imply that this rally still has some life left in it. But we aren’t there yet.

This week’s Investors Intelligence survey was little changed from last week: the bulls were at 48.3% and the bears at 23.1%. This is the only sentiment survey that is dancing to its own tune.

According to the AAII asset allocation survey equity allocation has reached 57% - a level last seen before the equity markets started their cascade down last year.

We touched briefly on the bond allocation at the beginning of the month. At 25% (a 9% point jump!) it is not only the single largest increase but also brings bonds to the highest chunk of the AAII portfolio it has ever been since 1987 when they started keeping track.

Finally, to round off, retail investors are finally feeling comfortable enough to leave the safety of cash. After the cash portion of their model portfolio reached a peak of 45% earlier this year, it is now down to just 25%. As I’ve mentioned before, there is a massive pile of cash sitting on the sidelines and it is slowly being deployed. Of course not all of it is ending up in the equity market, but considering the size of the build-up, even a small portion can have a significant effect.

The NDR Crowd Sentiment Poll is a proprietary sentiment measure from Ned Davis Research. It surpassed its extreme level (61.5) last week. Since then however it has backed off from this threshold and is now 4.3 points lower to 59.1 - this is similar to the other sentiment surveys covered above.

Fund Manager Survey
According to a Merrill Lynch survey of 204 fund managers, managing a total of $554 billion, 75% believe that the global economy will improve in the next 12 months. That is the highest level of optimism since November 2003. A smaller amount (70%) expect corporate profits to rise in the coming year.

Fund managers are putting money where their mouth. They have reduced their cash levels from an average of 4.7% in July to 3.5% in August - the lowest level since July 2007. They have also increased their allocation to equities sharply from last month. Merrill Lynch’s Risk and Liquidity Indicator, which measures risk appetites is at a 2 year high.

This dovetails nicely with what we are seeing from the AAII model portfolio allocation (above). The build up of cash was a sudden, fear induced spike. But the unwinding of it is more orderly as a gradual stream of investors decide that it is safe to venture out once more and take risks again.

Option Traders
The CBOE (equity only) put call ratio continues to fall as optimistic traders prefer calls to puts. Friday it closed at 0.51 meaning that traders were trading twice as many calls as puts. The simple 20 day average of this ratio is now at 0.587 - the lowest since June 2007:

Perhaps more importantly, the short term moving average has as a result, broken well below the multi-year rising channel that contained the put call ratio (red arrow).

The lesser known ISE sentiment index (equity only) reached a high of 202 on Friday. Being a call put ratio, this means that for every 100 puts, there were 202 calls being bought. But the short term moving average of this indicator is still treading water and not at an extreme.

Magazine Cover Indicator
Here is the August cover for Futures - a magazine dedicated to news and analysis of options, futures and stock trading. It is not a general interest magazine like Newsweek or even Business Week so I’m not sure how much contrarian weight we can put on it.

In any case, the image is of a hazy outline of a bull appearing in the distance. The implied question is, “It might be, it could be, is it?” meaning a bull market. Obviously this is the question that many are grappling with.

The interesting aspect of this cover is that it is not boldly trumpeting the arrival of a new bull market but instead timidly asking if it might be, could be true. And finally, wondering if it truly is.

By the way, if you have a US mailing address, for a limited time you can get a free subscription to Futures Magazine. I’m not sure how long this special offer will last so sign up right now.

Consumer Confidence
The preliminary Consumer Confidence survey from Reuters/University of Michigan showed a surprising decline to 63.2 for August - back to a level not seen since March 2009 when the market hit its trough. It would seem that the US consumer is being buffeted with the cross winds of deflation, which make things more affordable, rising unemployment and a schizophrenic stock market. No wonder then that they can’t seem to make up their mind:

The Dow Jones was in fine summer condition putting in the best July performance since 1989 and its best month since 2002. Are we in thin air territory yet? To find out, check out the sentiment summary for this past week:

AAII
After 6 weeks of the bears continuously trouncing the bulls in the AAII weekly sentiment poll - something we hadn’t seen since the low in March earlier this year! - the bulls are back. The most recent survey of retail investors shows that optimists rose 10% points to reach 48% and the bears fell 11% points to just 31%.

We need the retail investor to return to the stock market for there to be a real and prolonged recovery. But such a jump in sentiment is troubling. Previously it has not supported higher prices going forward.

Investors Intelligence
The percentage of bulls jumped to 42.4% and the bears decline to 31.1%. So we continue to see a healthy amount of optimism from the average stock newsletter editor, although not excessively so. And this week’s numbers take us back to where Investors Intelligence sentiment was at the beginning of this month - when the S&P 500 was trading some 110 points lower.

Money Market Cash Levels
Believe it or not, there is more than $3 trillion sloshing around in money market funds. But the nominal amount of funds isn’t really that helpful to us since just like GDP it continues to grow along with the economy. What is helpful in determining where we are in the big scheme of things is the movement between equity markets and money markets.

Obviously when investors are fearful, they sell anything and everything ‘risky’ and put their money in the protective but less lucrative vehicle of money market funds. That’s exactly what we saw in March of this year: Tsunami Of Cash Just Waiting To Be Invested. Unbelievably, the total assets of money market funds was higher than equity funds!

That has now returned to its normal historic ratio with total money market funds decreasing to just $3 trillion. But it isn’t only the return to the historical pattern that is noteworthy. What we’re seeing is not an orderly and mild shower of liquidity but a veritable tsunami as both retail and institutional investors move massive amounts of assets from cash. Not only are they moving record shattering amounts, they are doing so in just one month’s time. So whether this recent rally is the real thing or not, large and small players are reacting to it with the reflexes of a cobra.

While this may be interpreted as very bearish, you have to note that not every single dollar taken out of money market funds is automatically put in the equity market. In fact, only a small portion is destined there. Had every single dollar been invested in the stock market by the way, we would probably bee looking at the S&P 500 at least 30% higher from where it is. The rational take away from this measure then is that the participants in the financial markets are recovering from the shell shock they suffered earlier this year and late last year.

Option Traders
Yesterday when we briefly broke above 990 on the S&P 500 index, the CBOE put call ratio (equity only) hit 0.50 - that magically half point marker is significant because it shows the average option trader’s raucous disregard for risk as they reach for the long side. Historically, it takes the market a few days to digest this before reacting lower. However, the last time the put call ratio plumbed these depths was in mid-April, earlier this year. And it was totally ignored by the market on its merry way higher.

On Wednesday (July 27th 2009) the ISE sentiment index (equity only) reached 220. That’s the highest level since June 15, just before it started a protracted decline from the June swing highs. As well, we’ve seen several days of higher ISEE data so the 10 day moving average that I track has inched higher as well. The last time the short term moving average was around 170 was in early June, just as the market ran out of steam.

Rydex Market Timers
Traders in the Rydex family of mutual funds have once again reached for the stars. These are fast, market timers who switch between the Nova/Ursa (bull/bear) funds to make money on either side of the market. As a group, they are a good contrarian indicator when they reach an extreme. As they have now.

The last time they caused us to mind their positions was back in mid June 2009 when they had a herded into a bullishly lopsided extreme.

Insiders Selling
Corporate insiders are once again selling their own company’s shares at a pace that is alarming. According to Vickers Weekly Insider Report, more than 4 shares are being sold now for every 1 share bought by an insider. To find a higher ratio we need to go back to October 2007. While this may appear to be a bright, red blinking light, there’s more reason to treat it as a cautionary yellow.

That’s because insiders, for all their reputation, do not have such a great track record in timing their own shares. They obviously do have an edge on others but they aren’t perfect and certainly can be wrong. But more often than not, they are right but tend to act too early - by about a year.

Here is a quick wrap up of this past week’s sentiment data:

Sentiment Surveys
The American Association of Individual Investor’s (AAII) weekly sentiment survey had 38% bulls this week and 42% bears. That’s an increase in the ratio of optimists and a decrease in the proportion of pessimists. But all in all, we’re back to where we’ve been for the past few months - basically back and forth without hitting any noteworthy extremes.

According to the Investors Intelligence survey of stock newsletter editors, we had 36.7% bulls and 35.6% bears. That’s almost absolutely unchanged from last week. So once again, not much is changing in people’s perception of future stock market returns. And the results have the field split almost equally down the middle.

The Hulbert Stock Newsletter Sentiment Index which also measures stock newsletters who attempt to time the stock market is showing a surge in optimism. Among the group of market timers, the average recommended exposure to the market is +46.5% - this means that they are telling their clients to put 46.5% of their assets in the market (on the long side). The last time they were this optimistic was back at the start of the year - when, as coincidence would have it, the Dow Jones was also trading above 9000 as it is once again today. But I’m not convinced that this is a negative omen for the market since the level of bullishness is not extreme at all.

Options Sentiment
The CBOE put call ratio (equity only) actually increased along with the S&P 500 index. On Monday the put call ratio was 0.59 - suggesting that calls were almost twice as sought after as puts. By today the ratio had risen to 0.78 while the S&P 500 rose 28.13 points for the week. This parallel up move is a rare occurrence between the two indexes and it suggests that at least when it comes to the options market, there isn’t a euphoric acceptance of the rally’s longevity.

The ISEE sentiment index is also confirming the same nonchalant mood in the options market. Here is the updated chart showing the daily and 10 day moving average for the equity only ISE index:

If you look closely at the far right edge, you can see that the short term moving average has flat lined. Remember that the ISE is a call put ratio so the higher the number, the more optimism and the lower the ratio, the more fear it reflects.