Trader’s Narrative

Here’s this past week’s overview of sentiment data:

Sentiment Surveys

The retail investors and traders tracked by the AAII weekly sentiment survey continue to pull in their horns. The bears came in at 49% a 4% points increase from last week and the bulls were at 40%, a 6% increase from last week. Pulling back to provide some perspective, we’re still mired in no man’s land - neither optimistic nor pessimistic.

Similar to last week, the Investors Intelligence sentiment survey of newsletter editors was almost unchanged. There were 40.9% bulls, 28.4% bears and the rest neutral. The next test of sentiment is how it will react to a fall in stock prices. Will people throw in the towel? or persist in a new found optimism?

TED Spread
Although it was prominently featured everywhere just a few months ago, the TED spread has fallen off everyone’s radar now. After reaching a climax on October 10th, 2008 it has continuously fallen lower to reach levels that it was trading at in early August 2007:

It still has quite a ways to go to reach the multi-year lows of 15 but it is just another indicator returning to normal and signaling that the worst is over for the credit markets.

Volatility
The volatility index (CBOE’s VIX) continues to take one step forward, two steps back - slowly grinding lower. It gave up the 30 level again this week on its way lower. Mr. Market is remarkable, who would have every imagined that we would be seeing 30 as ‘low’? For a long term chart of the VIX and further details on what this means for the market, check out Volatility Continues To Melt Lower.

Options Sentiment
The ISEE (equity only) call put ratio was elevated for the whole week and for Friday it was 237 - meaning that for every 100 puts, retail option traders were purchasing 237 call options. To find an ISE sentiment index reading higher we have to go back more than 2 years to the last day of trading for the year on December 31st, 2007 when the ratio was 241 (and the S&P 500 closed at 1468.

Even so, I’d prefer to see more than a one day spike because the last time something similar happened, it turned out to be completely false. It was on March 9th when the ISE ratio doubled within a few days. But that was exactly when the market started this confounding rally. For that reason I’d prefer to see more than a few days of such extreme optimism.

The CBOE (equity only) put call ratio hasn’t confirmed the ISE optimism - which is another reason to not be jumpy. This week’s put call ratio was moderately higher but we didn’t see a significant change so the chart I showed in last week’s sentiment overview is still helpful.

Here’s this week’s sentiment landscape:

AAII
The retail investment survey carried out by the AAII is almost unchanged since last week with 44% bulls and 35% bears.

Investors Intelligence
ChartCraft’s survey of newsletter editors’ sentiment showed 41% bulls and 33.7% bears. Similar to the AAII survey, very little changed from last week. If anything, the undecided’s shrank.

Options Sentiment
The CBOE (equity only) put call ratio closed the week, very close to where it started it, at 0.63. Looking at a short term moving average, we’ve reached a level that has previously corresponded to market headwinds. The CBOE put call ratio has a slight upward slope, so the ‘low’ keeps shuffling higher. We are now back to levels which we last saw towards the end of March 2009 - of course, that didn’t stop the market from marching higher.

While the S&P 500 has been in a downtrend for the whole week, hitting a high of 920 and then closing at 883, you wouldn’t know that if you looked at the ISE Sentiment Index. Retail option traders, as measured by the ISE. On Monday and Thursday they bought almost twice as many calls as puts. That’s befuddling so let’s step back.

This chart shows the equity only ISE Sentiment index from January 2008 till now. Looking at the 10 day moving average of the ISE Sentiment, we can see that it is now at levels that correspond to past market tops :

Since 2008, whenever the ISE ratio reached 180 or so, stock market prices fell. The first case was in early January 2008 when the ratio reached 183. The second was May 2008 (174), which was the top of the first real bear market rally. The third was in the final days of 2008 when the Santa Claus rally petered out (173.5). And that brings us to today with the 10 day moving average of the equity only ISE sentiment ratio at 180.

Having said that, the ISE Sentiment’s 10 day moving average has gone much higher. On July and October 2007 it was 245 and 229. But the psychological tone of the market has changed from that time and it is more useful to look at the behavior of this indicator during the bear market.

Finally, notice that this options sentiment measure totally missed the March 2009 low - no indicator is perfect. This is why I look at the weight of the evidence rather than singling out any specific metric at any point in time.

Bloomberg Professional Global Confidence Survey
I mentioned this relatively new sentiment a few days ago at news.tradersnarrative.com. Since it was only started in November 2007, we have scant information for comparison but according to the participants, the global economy is on the mend. The BPGC climbed to 38.72 in May from 21.2 in April. That’s the biggest increase since the start of the survey. But because it is still below 50, it means that they view the economy as still contracting (but just not as much).

Also, for the first time since the start of the survey, investors are predicting that the Standard & Poor’s 500 Index will climb higher.

The respondents were most optimistic about Brazil and Mexico - shrugging off any lingering swine flu panic. And less enthusiastic about European market forecasting that France’s CAC 40, Germany’s DAX, the IBEX 35 in Spain and the U.K.’s FTSE 100 will decline.

Brazilian confidence climbed 11 percent to 62.6 - its highest level since June. As I mentioned a few days ago the Bovespa has been on a rampage posting the biggest monthly gain in four years in April 2009. The obvious explanation is that investors are betting lower interest rates and firming in commodity prices will propel their market higher.

Ticker Sense’s blogger sentiment poll is one of the lesser known sentiment measures so you’re forgiven if you aren’t familiar with it. The most recent survey results, from October 13th, show that there are no bears. Zero. None. Zilch. Three quarters are bullish while the rest are neutral or can’t make up their minds.

According to contrarian analysis, this might be a negative sign. Or maybe it is a bullish sign. After all, shouldn’t these people be “experts”? If they parse the market on a daily basis, invest and trade regularly, shouldn’t they have a better idea than the average person out there?

So does the runaway bullishness in this week’s sentiment survey mean that we should sell? or buy?

Neither.

I looked at it as a sentiment metric last year and found that as it turns out the Ticker Sense blogger sentiment survey offers no edge at all:

The conclusion I draw is that the poll is simply meaningless. It provides no significant piece of sentiment information we can use. At times it is bullish and at most other times bearish. But there is no connection whatsoever with the market.

This latest data point is the highest bullishness but I don’t think it really makes any difference. According to its past, the survey can not be used as either a contrarian measure nor as a straight indicator of any kind. Honestly, I’m really surprised that the folks at Ticker Sense are continuing this survey.

As you were.

Sentiment surveys are a great way to measure what the masses are feeling. Are they scared? panicky? greedy? apathetic? There quite a few sentiment measures out there. They each try to measure some sort of sentiment: from investment newsletter writers to Mom and Pop retail investors, to institutional strategists and now, thanks to Birinyi Associates we even have a blogger sentiment survey.

To be useful, a survey has to provide an edge. That is to say, it has to be able to give some reasonable signal related to the market. Usually sentiment surveys are interpreted from a contrarian point of view. This inverts the results so that when the survey shows an extreme bearishness, it is interpreted to mean that it is a good time to buy.

But there is no reason why a sentiment measure has to be contrarian. It can also be accurate. That is bullish when it should be bullish and bearish when the market it topping. The worst sin a sentiment survey can commit is to have no edge.

And I’m afraid the Ticker Sense blogger sentiment poll is guilty of this. We have data for almost a full year now and no matter how we slice and dice it, it provides no edge whatsoever.

It’s most obvious characteristic is that while the market has been relentlessly going up, week after week, the poll shows a consistent preponderance of bears over bulls.

But before you think that this means that we can use it as a contrarian measure, consider the other side of the coin. The rare time that the poll has shown more bulls than bears - only 5 times! or around 10% of the time - it has not been a reliable indicator of a topping market.

Out of the five times the poll has seen more bulls, three of those have in fact been good buying opportunities (see graph below). I suspect they were times when the bloggers grudgingly gave in to a powerful bull market - albeit for a very very brief period of time.

Below you can see a chart showing this (green dots are instances of more bulls than bears). I didn’t put a red X on the chart everytime a bearish consensus proved to be false because that would make the chart as red as a butcher shop:

The conclusion I draw is that the poll is simply meaningless. It provides no significant piece of sentiment information we can use. At times it is bullish and at most other times bearish. But there is no connection whatsoever with the market.

This reminds of last year’s experiment by Barron’s with a proprietary sentiment concoction from the hallowed halls of Citibank. For week after week this sentiment measure treaded water at a level they had marked ‘panic’. The market went up, the market went down. And still Citi’s sentiment measure mumbled ‘panic’. After a few months of fielding complaints from readers Barron’s withdrew the metric.

That’s what I suspect will happen with Ticker Sense’s sentiment poll also. The market is ruthless. If something has no value, it is discarded.