Trader’s Narrative

This week’s sentiment run-down has a lot of cross currents so be careful:

AAII
After last week’s sudden stampede to an extremely gloomy stance, the weekly survey of retail investors by the American Association of Individual Investors is showing a dramatic realignment to perfectly neutral. The bears and bulls both stand at 39% after a -/+17% percentage point change.

Investors Intelligence
The percentage of stock market newsletter editors who are bullish on the market fell to 44.4% from 48.3%, while bearish sentiment rose 2% points to 26.7%. This is a slight decrease in the ratio of bulls to bears, since we’ve been so accustomed to seeing it at 2:1.

To thoroughly confuse those with any leftover conviction, according to Consensus bulls on the stock market are at 74% - a previous high not seen since October 2007. Similarly, 78% are bullish on gold.

Daily Sentiment Indicator
The Daily Sentiment Indicator, calculated by Jake Bernstein, is showing an elevated level of optimism. The 10 day moving average of the DSI is at 70%, having fallen from the recent peak of 75%:

Consumer Confidence
The preliminary Reuters/University of Michigan Consumer Confidence index fell to a 3 month low of 66 (from 70.6 in October). Most analysts and economists expected a small increase in confidence. While it was unexpected, it shouldn’t be that surprising since the media has been filled with reports of the unemployment rate hitting the psychologically important 10% level. And as this is a preliminary number, it could be revised later.

The German ZEW Index
Looking across the pond, the most popular measure of German economic confidence, the ZEW index dropped to 51.1 in November from 56.0. The consensus was expecting 55.0. Meanwhile, the current situation index increased 2 points to -72.2 - with expectations being a rise to -69.

Mutual Fund Cash Positions
Standing on the “shoulder of giants” (aka Jason Goepfert), we looked at the level of cash being held by US equity mutual funds back in September. While being a ’sloppy’ market timing tool, its message was decidedly foreboding. And with the passage of some time, it has become more so as mutual fund managers are holding even less cash:

Corporate Insiders
According to Vickers Insider Report, corporate insiders have sharply curtailed their selling. Current buy/sell activity is 1:1.96 - that is on average, insiders are selling 2 shares for each they buy. Since compensation of corporate executives includes a healthy dollop of shares, it is natural for their activity to be skewed. However, since the long term average of the buy/sell ratio is closer to 1:6.5, the current level is rather bullish.

Google Investing Index
Google (GOOD) is a great source for sentiment on the stock market. Google Trends is where the search trends around the world are categorized allowing us a window into the public’s mood. For example, how much people search for “stock market crash” or “buy gold”.

Another metric is the Google Investing Index (GII) which tracks an amalgam of keywords related to investing such as “stock, finance, stocks” and so on. The peak of searches for these keywords was late last year on October 10th 2008 when there was an 86% increase in year over year activity:

Source: Google Finance

The opposite happened just recently in mid October 2009 when there was a decrease of 52% in people’s interest in all things related to investing. At least according to this specific measure. If capitulation is defined by total disinterest and apathy then based on the GII, we’ve arrived. This nicely dovetails with the complete withdrawal of US retail mutual fund investors.

Greybeards
Every once in a while I like to check in with a market ‘greybeard’ - my name for someone who has been around enough to see several cycles and has made more correct calls than not. This week, we review Albert Edwards at Societe Generale. He is an avowed bear who completely dismisses any talk of a recovery or bull market.

In a recent research note he flagellates himself for not having seen the ensuing rally off the spring lows:

To be perfectly honest, as the market powered ahead, I, like so many others, waited for the pull-back that never arrived. Do I feel like a grade 1 moron? Yes, I most sincerely do. Should I be beaten mercilessly to within an inch of my miserable life? Definitely.But I remain convinced we are still in a structural bear market and that this economic recovery rests on such shallow foundations that it will be washed away by the first moderate wave.

Always the grump, Edwards expects China to go into a recession, expects a similar fate for the US in 2010 with new lows for the stock market and a deflationary panic is in our future. You can find a recent report from him in the Free Trading Resource (Reports & Articles).

At the start of the week we contrasted the strange pessimism that has gripped the US retail investor to the levitation act of Wall Street. It is almost as if Wall Street threw a party and other than institutional investors, a few day traders and algo quant jocks jamming high frequency trades, no one else showed up. If you ask Paul Desmond, of Lowry Research, this is a real bull market that will last another 3 years.

With all due respect to Desmond, today I wanted to entertain some bearish counter arguments to temper that cheery outlook and delve a little deeper into the market condition both in the short and longer term.

While considering the same ICI fund flow data, it is conceivable to come to bearish conclusions. Take for instance the fact that domestic equity funds have attracted less than $8 billion of fresh capital since the lows in March. Had this rally provoked the same pattern of retail investor participation as previous ones, we should have seen $150 billion flow to equity mutual funds, according to TrimTabs.

Maxims ad Nauseum
While it has become an accepted maxim repeated ad nauseum that a bull market likes to climb a “wall of worry”, the historical evidence is otherwise. The stock market actually tends to float higher on gradually increasing levels of optimism - until that optimism reaches a crescendo and then the whole thing unwinds. And we start all over again. So generally speaking, the stock market performs better following periods where there are net inflows of funds.

Whether retail investors are acting intelligently by avoiding this rally or more accurately, by selling this rally, is something that only history can answer. It isn’t hard to imagine though, the possibility that they are reacting emotionally. Think of it. Having first experienced severe loss in their portfolios and watching Wall St. insiders ride on a cushion of bonuses, insult is added to injury when they have to fend for themselves in a new harsh economy.

What if we are seeing the rejection of the great “equity culture” and the almost religious belief in “buy and hold”? What if the record inflows to bond funds are being driven by a traumatized populace seeking the one shelter of income investing?

So far, this has been so relentless that it has pushed the fixed income share of US household wealth above 6% once again. But if you notice, the last time there was a similar increase happened during one of the strongest bull markets in equities:

However, what is undeniable is that if the US retail investor doesn’t return to equities eventually, what we could see is another lost decade; where markets flop around like a dead fish, but don’t really go anywhere. This is what happened before the great super-bull market was launched in 1982.

The completely stark scenario is one where retail investors continue to ratchet up their sales of equities and push the stock market lower as a cascade effect takes place where gloomy sentiment and fear feeds on itself. Think of it as the great unwinding; or the negative wealth effect.

Technical Weakness
Returning to more present and short term matters, the market came perilously close to the invisible 20% distance from its long term moving average. Yesterday I mentioned that stocks have little room to the upside and while I’m not surprised to see the weakness today, it by no means guarantees that we won’t see a final push to 1120.

On Monday 94% of the S&P 500 stocks closed above their 10 day moving average. That’s the highest since mid July. Since then this measure of breadth has backed off slightly but is still hovering above 90%. Other negative technical considerations are that prices are pressing against the downtrend line at 1100 - from the top of the bear market (in October 2007). And that other major market indexes like the Nasdaq, Russell 2000, the Philadelphia Banking Index (BKX) and the Semiconductors (SOX) are still below their previous swing highs. Finally, volume continues to be anemic as it has been for most of this whole trip.

For economic and market news and to see what interesting reading you may have missed last week, check out the list below. To see it all, go to news.tradersnarrative.com:

• Bill Moyers interviews James K. Galbraith
• Market Is Strong, But Correction Should Continue
• Contrarian analysis remains bullish
• Goldman’s long term borrowing cost 0.92%
• Get a FREE Subscription to SFO Magazine (US residents only)
• EU to break up Lloyds, RBS and Northern Rock
• Schwab Creates Watershed Event with Commission-Free ETFs
• CNN Interviews Robert Shiller on Economic Recovery
• EWI FreeWeek almost over, hurry! Learn more about FreeWeek, and download your free reports here
• Mother of all carry trades faces an inevitable bust
• Four Simple Ways to Fix the Broken System
• Clever fools: Why a high IQ doesn’t mean you’re smart

The above is a small sample, for the complete list, follow the graphic link below to news.tradersnarrative.com:

And remember to check back during the week as there are interesting links added throughout the week. If you are a twitter user, add the news.tradersnarrative.com twitter stream to get new stories in real time.

The Week Ahead:

This week the sentiment data brings a very intriguing turn of events so let’s get started:

Sentiment Surveys
The star this week is the ever so humble and common AAII weekly survey of US retail investors. This sentiment indicator sends extreme signals every once in a blue moon. So I guess you better check the night sky tonight because we haven’t seen so few bulls in this survey in a long time.

This week’s AAII results show only 22% bulls and a whopping 56% bears. The last time we saw this few optimists and this many pessimists was the week of February 19th 2009. Just before the spring rally. To put that in (even more) perspective, out of all the data that we have so far, only 4% of the time have there been less bulls.

Here is a chart of the bull ratio (bulls divided by the total number of bulls & bears):

I’ve zoomed in to the past 7 years or so since showing the whole time series from 1987 would be overkill. From 2002 till now, there have been 8 instances where the AAII bull ratio was less than 30%. But as the last extreme reading in February suggests, it is best to not act in haste when presented with such a scrumptious contrarian gift. Historical data suggests that sitting on your hands for the next few weeks is the most prudent strategy (for longs).

I hope that I haven’t understated the gravity of this week’s AAII sentiment survey result because there is a high probability that it will once again prove to be prescient in pinpointing an upcoming inflection point. It is most definitely a tell that after a 55% rally we find the AAII bull ratio at such an extreme low when in early 2004 after a 37% rally from the 2003 lows the bull ratio was at the other extreme (see above chart).

The one puzzling thing is that the AAII asset allocation survey shows a slight uptick in equities (to 57%) while back in February when the bull ratio was so low last, it was closer to 40%. I guess the message the AAII folks are sending is that they like equities longer term but short term they’re very nervous. And that’s remarkable because of how little off we are from the year’s highs.

Investors Intelligence
While this week the AAII deservedly monopolized our attention, the measure of newsletter sentiment from ChartCraft is a snoozefest. The II this week is almost completely unchanged with 48.3% bears and 24.7% bears for a (yet again) bear to bull ratio of 2:1. I’m not sure how to reconcile these two disparate metrics but I do know that this is really nothing new as they often conflict with one another.

Hulbert Newsletter Sentiment
Thankfully, we have another measure of newsletter sentiment. Currently, the Hulbert Stock Newsletter Sentiment Index (HSNSI) stands at 3.2% - which implies that the average recommended exposure by short term timing newsletters is to be long 3.2% of their client’s portfolio.
Continue reading ‘Sentiment Overview: Week Of November 6th, 2009′

Gold has the wind at its back right now. Not only has it cleared the challenging $1000 resistance level, it has support from lax monetary policy as central banks around the world clearly hold the health of their economy in higher priority than the health of their budgets or their currencies.

The recent purchase by the central bank of India is being interpreted widely as a vote of strong support for the precious metal. Although I don’t argue against a secular bull market, it is amusing to me that a decision to buy gold at above $1000 is deemed to be a ’smart’ move when just a year ago they could have made the same purchase for 30% less. The fact that almost any news is interpreted as positive for gold has more to do with the prevalent sentiment than with facts.

In any case, before we get to the short term sentiment for gold, here is the recent commentary from David Rosenberg of Gluskin Sheff on the monetary backdrop for a secular bull market in gold:

All India did was bring gold to a 6% share of its total FX reserves from 4%. Fifteen years ago, that representation was closer to 20%. China has increased its gold holdings by 76% over the past six years but they are a mere 1.9% of the aggregate 2.2 trillion of reserves and Russia’s gold holdings is just under 5%. This is not the 1990s when Bob Rubin was running a hard U.S. dollar policy, U.S. fiscal deficits were vanishing and gold production was on the rise. Today’s world is exactly the opposite. Policymakers beginning in the 1990s wanted disinflation and got it. Now they want inflation — it will take years, maybe a decade, but it will come. For the near-term, we are still optimistic on Treasury securities but be forewarned that this view has an expiry date that is earlier than the peak we are likely to see in gold.

It is very clear that central banks are behaving in a way that would suggest that gold is now again being considered a currency within the global monetary system. As we said before, it is all about relative scarcity and a well-defined supply curve — fiat currency at this juncture does not share that quality.

Turning to the breadth in the gold stock sector, you can see that we’ve seen a sudden and dramatic jump from a week ago. The chart below compares the percentage of gold stocks trading above their 10 day moving average with the Philadelphia Gold Bugs index (HUI):

If you’re interested in timing the gold market, then you would be concerned that 82% of gold stocks are trading above their short term moving average. But you would also be alarmed that just a few days ago, that number was below 10%. Historically, gold shares have a very tough time continuing to climb when faced with such short term headwinds.

Turning to sentiment in the gold sector, on Monday when we looked at the arguments that Paul Tudor Jones II presented for his case of a secular bull market in gold, we also digressed a little to check the Hulbert Gold Sentiment index. That sentiment measure was showing a majority in the bullish camp; which from a contrarian point of view means that gold probably will have difficulty in advancing in the short term.

In a similar vein, here is a chart, courtesy of Elliott Wave, which shows the price of gold with the Daily Sentiment Index (DSI). The most recent DSI is 91% which is just about where previous short term tops have been formed:

Similar to the breadth measure (shown earlier) the DSI increased to 91% in a sudden jump (an 8% point jump over a day). Accoding to Elliott Wave, which tracks the DSI, this was the single largest increase since March 19th 2009 (11% point jump from 75% to 86%) when gold made a two month high at $960. With Elliott Wave, not only do you get their analysis of various markets but they do a good job of monitoring DSI, which is a proprietary sentiment metric from trade-futures.com and by itself would costs about $2000/year.

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