Trader’s Narrative

AAII
The retail investors as measured by the American Association of Individual Investor’s weekly sentiment survey are astonishingly pessimistic: 54% bearish.

To find a more gloomy view from the retail investor’s camp we’d have to go back to mid January when the AAII sentiment reached 59% bearish.

Back then I showed you this chart:

We have definitely seen 13 weeks pass since then and within a few more weeks will also complete 26 weeks. But unlike the historic average shown in the bar chart above, the market has yet to hold a decisive rally.

The S&P 500 Index (SPX) did momentarily reach a high of 1440 but couldn’t hold on to it. For most of the time we’ve been trading below the levels at which we first saw a +50% bearish AAII sentiment. As I’ve outlined before, sentiment during a bear market is a different beast.

Hulbert Newsletter Sentiment
Mark Hulbert is worried that while we may have put in a significant bottom with the March low, it may not hold. According to the Hulbert Stock Newsletter Sentiment Index (HSNSI) the average exposure recommended is a paltry 2.2%. And while this is low, back in early March the average newsletter editor was downright panicking with a -29.2% exposure - meaning actually being short the market with almost a third of total portfolio allocation.

As we head into a possible retest, it isn’t reassuring to see sentiment sitting so much above those levels. The ideal sentiment that would catapult us higher would be an even more intense panic with the kind of market weakness we’ve seen. While that may change anytime, the HSNSI doesn’t reflect that right now.

Investor’s Intelligence
No significant change in this sentiment measure: bullss dropped from 44.8% to 43% and bears increased slightly from 31.1% to 32.6%. It isn’t offering much of an edge as it sits in lukewarm waters similar to the Hulbert analysis.

CBOE Put Call Ratio
While the traditional put call ratio (equity only) did rise during the turmoil of this week, we didn’t see it reach or exceed the important 1.0 milestone. In fact, it only was able to muster a high of 0.84 on Wednesday. That reflects a good amount of fear but just not enough to carve out an important inflection point.

ISEE Sentiment
This past Wednesday and Thursday the ISEE Sentiment measure fell to 74 and 75 - the lowest since mid March low this measure reached 56 (March 10th 2008).

Remember, the ISEE sentiment numbers are calculated differently from the CBOE put call ratio. For one, the ratio is inverted with calls as the numerator and puts as the denominator. Further, the ISE only uses options which are traded by non-market makers, stripping out the noise and showing what retail and institutional traders are doing. And lastly, the ISE data is for opening orders only.

All in all, a much more robust and useful measure of options trading sentiment.

Rydex Traders
According to Jason Goepfert:

Rydex traders had finally started focusing on “safe” funds more than “risky” funds - a stark change from earlier in May when they were five times more likely to trade a risky fund than a safe one. As of yesterday, the ratio fell under 0.5, meaning that those folks were more than twice as likely to trade a safe fund than a risky one.

Conclusion
Since I eschew using a single indicator to light the way, the weight of the indicators are confusing with many cross currents pulling me in different directions. The troubling and somewhat muddy sentiment outlook doesn’t help. Hopefully things will resolve themselves soon and the picture will become clearer.

I took a few days off (hope you didn’t miss me too much). Let’s catch up by looking at the important sentiment developments:

ISE Sentiment
I mentioned the ISEE during last week’s sentiment overview when it increased slightly as the market fell, showing that retail option traders were seemingly not worried. Even more bizarre, during the past shortened trading week as the market staged a strong recovery, the ISEE value actually fell.

Part of the explanation for this aberrant behavior may be that I’m looking at the “All Securities” data for the ISEE, rather than the “Equities Only”. The latter measure showed no similar increase for the week of May 23rd.

CBOE Put Call Ratio
Again, in contrast to the ISEE’s behavior, the CBOE equities only put call ratio showed this past week that traders became more bullish as the market rose. Although not the ideal, this is the normal pattern.

The put call ratio fell to 0.59 - approaching levels of bullishness which have previously caused stock market rallies much difficulty.

Hulbert Newsletter Sentiment
According to Mark Hulbert, the Hulbert Stock Newsletter Sentiment Index (HSNSI) has almost doubled from +16.2% to +31.2%. And it did so from mid May to the end of May 2008. Although this is an significant increase, I don’t think it presents us with a situation commensurate with market top.

To give you an idea, during mid to late April 2006 the HSNSI reached +73.2% - when the S&P 500 index soon after fell from 1325 to 1225. And during the bear market bottom in October 2002, it fell below -60%. So all I can say from the current reading is that more newsletter editors are jumping into the bullish camp but still not enough to cause serious problems.

AAII
According to the American Association of Individual Investors’ sentiment survey, there are now 31% bulls, down 15% points from last week’s 46% bulls.

This is a welcome reprieve, especially as it is accompanied by a lower market. Had this key sentiment survey remained unchanged or actually increased in bullishness, the sentiment tone would be definitely different.

Investor’s Intelligence
Similar to the AAII survey, the II sentiment measure fell from 47% bullish to 37.9%. I was worried about this since last week’s number was almost 50%. The keepers of this measure, the editors of ChartCraft, Burke and Gray agree with my general take on the market’s sentiment:

“While the sentiment is moving away from a bullish reading it is not yet close to calling for a market top”

I continue to see a lot of long term positives for the market and continue to believe the March bottom to be a major one. What I suspect we are seeing is a (hopefully) shallow pull back or pause before the next leg up.

Magazine Cover Indicator
Uh oh. Anyone long crude oil or any traditional energy related equities should be worried.

The Economist isn’t the most widely read publication but their cover stories still do carry weight - in a contrary sense most of the time. The price of crude has already tapered off and I suspect this will be either a significant top or at minimum a longish pause.

There are, of course, other signs that the whole energy rally has run its course. There are several technical signs, including the increasingly sharp slope of the trendlines as well as ominous candlestick formations.

Here’s this week’s sentiment summary:

NASDAQ:NYSE Volume
I touched on the relative lack of volume and how this has historically marked tops, rather than spurred on rallies. Another troubling volume development is the ratio of volume on the Nasdaq compared to the NYSE. We are seeing a spike in this ratio, meaning that Nasdaq volume is significantly more than NYSE volume. Since the Nasdaq represents the riskier side of the market, this has usually meant that there is too much froth in the market.

Sentiment Surveys
Last week I pointed out the danger of having the AAII remain at 53% bullish when the market had gone down slightly. Although this week the AAII respondents were slightly less bullish (45%) it is good to see their excitement abate in the face of a week that saw the market go up.

This reversal however only slightly dilutes the contrarian bearish meaning of this indicator. We are still at a very high level of bullishness. Simply by receding from the extreme level of bullishness that we saw last week does not eliminate the topping signal that the AAII is giving us at this point. After all, it was in October 2007 when we last saw this sentiment measure at such heights.

Investor’s Intelligence, the measure of newsletter sentiment compiled by ChartCraft, showed little change going from 44.4% bullish to 46% bullish.

Hulbert Newsletter Sentiment Survey
In contrast to the sentiment surveys mentioned above, the Hulbert Stock Newsletter Sentiment Index is continuing to suggest that newsletter editor are still either skeptical of the market’s recovery or not really excited by it.

At the start of the week, the HSNSI was 16.2%, meaning that the average market timing newsletter was suggesting to their clients being long just 16.2% of their portfolio. This is much lower than the 27.5% which they were recommending in late April, even though at that time the market was lower than it is now.

Slicing and dicing the newsletters, Hulber finds that the stock market newsletters with the best track record of timing the market are continuing to be bullish, while those that have lagged buy and hold are much less so. This gap in sentiment and performance has, however, significantly diminished from mid-March - when the market hit its inflection point.

Is LowRisk Dead?
A reader already asked about the lack of updates from LowRisk. I emailed Jeff Walker, the keeper of the data and when or if I receive a reply I’ll write a follow up. The last update on their site is for March 23rd 2008. I haven’t received any email updates either - I’m subscribed. In any case, LowRisk was never one of the major sentiment surveys that I relied on. It was a bit too volatile and no one except Walker knew the size of the sample size.

Magazine Cover Indicator
Here’s an interesting magazine cover for analysis (below): “Barbarians at the vault”. It is the latest Economist cover showing a bank being besieged by a horde of angry “barbarians” carrying banners with such slogans as :

• Skin the fat cats!
• Just say no to CDOs
• Regulate now
• Salary limits

The building is on fire, there is a column being pulled and there are sledgehammers being taken to its pillars. Pretty powerful imagery. I wonder how it will play out with the Philadelphia Banking Index being where it is:

Check out the Economist’s “prowling bear” cover in 2006. As disclosure, I’m long the AMEX Financial Select Sector ETF (XLF).

A little late due to travel, but as they say, better than never…. here’s the sentiment recap for the past week:

AAII
Still too many bulls in this sentiment reading (40%) but the bears are still outnumbering them at 46%. There’s no denying that during this correction the Mom’n'Pop retail investors have come across as outright cold-blooded creatures. My own personal theory is that they simply don’t care about the stock market because they have very little invested and therefore, little at stake.

Investor’s Intelligence
No real change in this indicator. The newsletter writers are pretty much where we last left them last week: about equally split between the bulls and bears.

I’m a bit puzzled why this sentiment indicator is so flaccid. Especially when you consider that according to Hulbert, newletters are rather spooked (see below). My hunch is that Chartcraft and Michael Burke (editor) have a slightly different interpretation of newletter writer’s intentions. You have to remember that unlike many of the other sentiment measures, this one involves a subjective call which categorizes the letter as bullish, bearish or neutral.

Hulbert Stock Newsletter Sentiment
The HSNSI closed August at +5.5%- this means that for the newsletters that try to time the market in the short term, they are on average only recommending being 5.5% long this market.

Although this measure has risen from about two weeks ago when it reached -11.3%, it still provides us bulls with some ammunition. That’s because in the face of a ~600 point rally in the Dow, the newsletter timers have only dipped their toes into the stock market.

Had they rushed in wholesale, things would be different. But they are obviously still timid and only reluctantly admiting that the market isn’t all that bad after all.

Consensus
Consensus bullish sentiment reacted sharply to the market’s gyrations by jumping 7% last week. It had plumbed depths that it had only seen before during last year’s August correction.

Market Vane
In contrast, Market Vane hasn’t really budged. At 53%, it is still quite low. And although I referred to an interesting interpretation of its recent behaviour during the last weekly sentiment review, I still think it should be interpreted from the traditional upside down, contrarian point of view. So nothing new here.

Massive Doomsday Options Trade
Finally, I wanted to touch on the story that has been making its way around the internet, trading discussion forums and even CNBC: that a massive options trade has been put on which predicts that the market will crash in the coming months.

The details of the story are pretty much everywhere. I found mentions even on digg and reddit. Ugly mentioned it a while back when it was just going viral. Make sure you also check out the discussion in the comments section.

When I heard it, I must confess, it made me chuckle.

Would anyone really put on a one sided options bet like that? and would they do it via the very public options market rather than the more private swap market?

If you believe this conspiracy theory, you need to get in touch with me stat. I’ve got a wonderful bridge in Estonia to sell you for a very reasonable price.

But seriously, this sort of doomsday story goes viral because it feeds on people’s fear (and ignorance). And that is a truly insightful contribution to sentiment.

Since over here we practice contrarian analysis when it comes to sentiment, this is exactly the sort of brick that walls of worry are built from.

Rundown of the usual and unusual sentiment measures for this most interesting trading week:

Hulbert Stock Newsletter Sentiment
The HSNSI measures the average stock market exposure among a subset of short-term market timing newsletters. As of yesterday’s close it reached -11.3%. Last week it was +8.6% when I pointed out that although that was low, usually we need to dip into negative territory. Its historic range extends from +79.7% to -81.8%. But the really negative stuff is for bear market bottoms.

Investor’s Intelligence
II’s bearishness has increased precipitously as the market has fallen. As the market topped they numbered around 22% but now they are 32.6%. That may not seem like a high number but relative to previous II readings, this is close to reaching its extreme. The bulls have likewise dropped from around 55% to 43.8%.

AAII
Puzzlingly the retail investors at the AAII have been very reluctant to become defensive. This week they finally inched their way into the bear side with 46% bears and 42% bulls. Although they’re going in the right direction, reducing bullishness by 4% points and increasing bearishness by 7% points, they haven’t really responded in the usual skittish way.

Market Vane
After I wrote about Market Vane last week, a reader pointed out that it may not be contrarian after all. They mentioned that in the past MV becomes bearish just as a major bear market or crash is about to occur. I’ve looked over the historical chart and I can’t really see this. Plus, they’ve already incrementally decreased their bearishness (by 2% points to 58%). So I’m still regarding this through a contrarian lense and see it as a bullish omen.

ISEE Call Put Ratio
As I pointed out although the ISE call put ratio didn’t reach a daily extreme reading, the ISEE index’s 10 day moving average did fall to historic lows seen only twice before. Things have been a bit wonky with the ISE and eventhough I’m pretty sure this data is accurate my trust has been eroded by their inexcusable lack of transparency and communication about their error.

CBOE Put Call Ratio
The traditional put call ratio (CBOE equity only) spent three days above 1.0 this week: Tuesday 1.08, Wednesday 1.05, Thursday 1.02 This is highly unusual and indicative of sustained fear. Obviously after today’s strong showing it declined to 0.75.

Conclusion
Although sentiment didn’t or hasn’t reached the kinds of extreme’s that I’d like to see at a significant market bottom, there is no question that we have pervasive bearishness out there. Here’s what appeared on the front page of digg this morning:

It linked to an article at Slate.com which in fact didn’t say anything remotely similar to the headline on digg. Nevertheless, it was dugg and made it to the front page. Perfect unorthodox contrarian indicator.

Did you find any other ones?