Trader’s Narrative

The early March preliminary Reuters/Michigan consumer sentiment survey results were bad enough, coming in at 70.5 and they got worse when they were finalized at 69.5 in late March.

“A recession has occurred whenever the Sentiment Index has declined as much as it has fallen during the past year, including the recessions occurring from the mid 1950’s to the early 2000’s,” according to Richard Curtin, the Director of the Reuters/University of Michigan Surveys of Consumers

The full press release is available on the Reuters/Michigan website and also in my box of free trading goodies (in the Articles & Reports folder, named “Michigan Consumer Survey March 2008″).

A recession you say? Well, I’ll be!

There are several measures that Reuters/Michigan tracks. One of them is the “expectations index” which looks ahead to quantify how consumers see their future. In March 2008, this index hit (47.9) the lowest it has been since the 1973 recession (45.2).

Yes, you read that right. Today… US consumers feel almost as hopeless about the future, as they did in the days of the oil shock, a brutal bear market, the rationing of gas (depending on your plate number), etc. Unbelievable!

Here’s a historical chart of the Reuters/Michigan survey going back to early 1970’s:

As you’ve probably surmised by now, each time that consumer sentiment has scraped the bottom of the graph, the stock market and the economy have stopped their decline.

Starting with 1975, this was the end of the brutal bear market. Although equities didn’t bounce back, they stopped declining and entered a period of consolidation.

The early 1980’s saw the break out from this consolidation and the launch of the great secular bull market.

In 1990, the consumer sentiment spiked lower and the stock market followed with another significant long term bottom. Subsequent shocks in 1992 and 1993 don’t show a concomitant reaction from the market.

The next time consumer confidence approached such levels was in early 2003, which was the bottom of the bear market that followed the bursting of the tech bubble.

And now we are once again approaching these same levels. Which makes me wonder why consumers don’t have a long term memory? Collectively we seem to react with the IQ and recall ability of a one cell amoeba.

Here are some more historical charts of consumer sentiment as measured by the Michigan University survey.

According to sentiment, it is time to sell bonds (and buy stocks).

Bond Market Sentiment
A few days ago the Hulbert Bond Newsletter Sentiment Index reached 47.4% — that’s four times the average sentiment over the past year and eerily enough, it is a repeat of what happened last year at this time. We had a slightly higher level of bullishness last November as bond prices carved out a major top.

Two other bond sentiment measures also show a dangerous level of bullishness. Market Vane sentiment survey shows 68% bulls - you’d have to go back to 2005 to find a higher level. And Consensus Sentiment shows 63% bulls, down from a recent peak of almost 80% but still quite high.

According to contrarian analysis, you want to fade the crowd and that would mean selling bonds.

Chart Request
In the comments section of my update on the timing the stock market using the rate of change of the 10 year T-Bonds, scood asked for a chart of the same covering the 2001- 2004 timeline:

It depends on how you want to interpret that signal. One could see it as a failure or success since price meandered before continuing to rise again. If you want to be really strict, it could be interpreted as a failure since price didn’t immediately go up.

In any case, nothing is 100%. This and other indicators are mere guides and should only be used as such.

I know this is a bit late but lets cover last week’s sentiment landscape:

Hulbert Stock Newsletter Sentiment
According to Mark Hulbert, there is a stark contrast in the land of newsletters. The newsletters with the best track record in timing the stock market are bullish with an average 83% equity exposure. Contrast that with newsletters with the worst track record which are bearish with an average of only 9% exposure.

LowRisk 30-Day Outlook
Last week this survey had 64% bearish and only 18% bullish. That was a head spinning change of mind from the week previous to that when there were 34% bears and 50% bulls. As I’ve said before, LowRisk is a very volatile sentiment survey but nevertheless, this level of bearishness should be noted. The last time we saw something similar was back in August 2007.

Investor’s Intelligence
In contrast, newsletter sentiment as judged by II shows 51.1% bulls and 26.7% bears. Although that is down a bit from the 60+% of bulls the survey was showing just a while ago, it is still quite bearish from a contrarian point of view.

AAII
And to thoroughly confuse you, the retail investors are actually rather fearful: 50% bearish and only 33% bullish. This level of sentiment has corresponded historically with important intermediate stock market bottoms.

ISE Sentiment Index
Last week (November 16th) the ISEE sentiment index fell to 68 - that is, 68 long call options were initiated for every 100 put options. This is not the extreme historical lows but it is low enough to be a strong signal. Perhaps of an upcoming intermediate bottom being carved out from abundant fear and loathing.

Magazine Cover
According to the Economist, the US economy is about to be gobbled up by a recession? sub-prime mortgage and/or credit crisis? the disappearing dollar? I have no idea what the shark is supposed to represent exactly.

But it doesn’t matter since the Fed seems to agree. At least thats what it seems from the newly released minutes of the Oct. 30-31 Fed meeting. The Fed Funds futures market has now built in another 25 basis point cut when the Fed meets next in December.

Hmmm… that sounds remarkably familiar. Where did I read about the Fed cutting rates in the summer before they started slashing? And then again about one last rate cut before the year’s end?

It just rings a bell

The sentiment overview for this week in the markets:

Sentiment Surveys
The usual suspects: AAII, Investor’s Intelligence, LowRisk, Consensus and Market Vane did not vary significantly over this past week so I won’t go into detail.

ISE Sentiment Index
Although technically a measure of options activity (ratio of puts to calls), the ISE Sentiment Index (ISEE) reached a 32 trading day high yesterday at 151. Today’s reading hasn’t been release but going by the intraday data, my guesstimate is in the high 140 range (UPDATE: 154). The 10 day moving average of the ISE put/call ratio has reached 118, well off its multi-year low in the 90’s range - where it gave a wonderful signal to mark the inflection point.

Magazine Cover Stories
This unusual sentiment indicator only gives signals sporradically but when it does, it pays to take notice. In August there were multiple negative cover stories. Here are 3 that I caught:

Notice the liberal use of the color red (with its obvious and subconscious connotations). Also, the Economist cover art not only shows a surfer, perilously hanging ten - about to be engulfed by a larger wave behind him - but those grey specs are four sharks in the water waiting for the inevitable.

The last time I featured a negative Economist cover was last summer when they ran a photo of a bear in the woods, just as the stock market was in the middle of its correction. The swoon lasted another month and prices dipped slightly lower than when the cover story appeared but clearly the worst was already over.

And lest you think that cover stories only have contrarian power when they are bearish, consider the glowing Akamai cover story in Forbes magazine in mid-April when it was trading around $50 a share. Now it is scraping $30.

Alright, so by now we know that the ISE sentiment data on the official webpage is wrong. Thankfully I was able to correct it as best as possible. It helped that only the past few data points are suspect.

In any case, seeing how the ISE sentiment helped me turn cautious just at the top of this market swing, I’m not giving up on it yet.

But I’m reduced to using my own graph (see below) as their’s is wrong (and still neither corrected nor noted as such). Sheesh. I hope they get their act together. So the chart uses correct data (as far as I can be sure) not that crazy 51 data point.

I looked at the 10 day moving average as my guide, just as before. This time however this short term moving average is saying that the ISE sentiment index is about as low as it has been. Other than the March 2007 bottom, to find a similarly low reading we’d have to go back to the end of the bear market.

I’d still like to see atleast one day of major capitulation showing up on the ratio. Something in the range of 50-60. And atlhough we may get it, it may not be necessary. Rather than a whoosh down which has been the script so far, we could just meander and muddle through for a bit as people are bored to death rather than scared to death.

Click To Enlarge Graph:

Thin green line is the 10 day moving average of the ISE Sentiment Index while the thick blue line is evryone’s favourite market proxy.