Trader’s Narrative

Eventhough I still think of this as another bull market correction, I bemoaned the lack of real fear in the market. Now, this final puzzle piece seems to be falling into place.

Panic T-Bill Rush
Among the strongest signs of real fear in the market is the mad dash to the safe harbour of risk free short term treasury bills. This past Monday we saw a dislocation in the fixed income market that is seldom seen. But whenever it does rear its ugly head, it is a sign of better times ahead.

This kind of fear and loathing doesn’t register on the usual sentiment indicators that most people watch. But as a reflection of a market that is now mostly made up of institutional asset managers and other large players, it is a very important tell.

AAII
This is the most stubborn sentiment survey, in that it hasn’t really registered a panic or shown any real fear. The AAII bears only number 43%, down from 46%. Usually the retail investor gets so spooked that the percentage of bears spikes beyond 50% - as it did in early March of this year.

However, my working theory is that since the retail investor has been pulling money out of the market at record rates, they are simply not a meaningful participant in the market. According to estimates from TrimTabs, they are sitting in bonds and money market funds (see video). So if they do not have anything substantial at stake in the stock market, why would they get bearish and panicky?

Market Vane
After a small hiccup, this sentiment survey fell to 52% which is the lowest it has been since late 2003. From a contrarian point of view, this is bullish because even as the market has recovered, there are now even more bears. It would seem that the majority of the CTA’s that Market Vane tracks do not believe in this recovery. That gives me even more confidence that it is real.

Especially interesting since the last multi-year bearishness in Market Vane, here’s a different perspective from Yang’s MarketTells.com:

Historically, this group has a strong track record of turning bearish on stocks (meaning a reading below 50%) ahead of virtually every significant selloff of the past twenty-five years (see long-term chart.) They were bearish ahead of the ‘87 crash, ahead of the ‘98 mini-crash and held a persistently bearish outlook from early 2000 right up until mid-2003. Since then, they’ve maintained a consistently bullish outlook. As I said, they have an enviable track record… it will be most interesting to see if their outlook rebounds out of this territory, as it did in recent years, or if this group finally throws in the towel and switches to a bearish outlook. Should that occur, it would be a significant red flag for the stock market’s longer-term outlook.

Looking at a long term chart of Market Vane’s bullish percentage along with the S&P 500, what I see is a great contrarian indicator. The only unique characteristic of Market Vane is that it settles itself into multi year ranges. As long as you use some sort of bracketing structure around it, like for example bollinger bands, it is useful. Trying to out think a simple sentiment survey will not yield much. And in any case, it is only one single tell. Much more important is the total picture that all indicators paint together.

Investor’s Intelligence
One of the longest running sentiment surveys, the Investor’s Intelligence keeps track of newsletter writers’ sentiment. Because of the nature of their business, newsletter writers are by and large a bullish bunch. After all, positive, cheerful newsletters sell better.

So it is very rare to see more bulls than bears. Usually stock market inflection points are carved out when the bull ratio (bulls divided by the sum of bulls and bears) nears 50%.

This week the II bears finally increased to 37.4% making the bull ratio reach 52%. We haven’t seen this many bears in this sentiment indicator since last August and early 2003 when the bull market was launched. The difference is that while that occurred after a catastrophic fall in prices, this level of fear came as a result of a 12% decline from all time highs.

All in all, this is the sort of fear based capitulation I’d like to see. It came a bit late but no doubt it was a result of the swoosh down we saw last week as the S&P 500 broke through its 1460 technical support area.

Low Volume Skepticism
Having seen prices rally sharply higher, the perma-bears are clinging to their last possible straw: low volume. I would advise them to throw a glance towards the general direction of a calendar. We are in the thick of the summer doldrums.

And yet, the average volume on the exchanges is anything but anemic. In fact, this is the highest volume August for many many years. The spike in volume accompanied the capitulation as the smart money rushed in to buy what the weak hands were selling.

Now they are sitting back and waiting. As Jesse Livermore used to say, it is the sitting that makes you money.