Trader’s Narrative

Here’s this week’s sentiment wrap-up:

Investors Intelligence
According to ChartCraft, the keeper of the Investors Intelligence weekly stock newsletter sentiment survey, we had a small increase in bulls to 28.4%. And about the same magnitude decrease in pessimism to bring the bears to 44.3% of respondents.

This week’s low level of bullishness provides some hope but compared to late last year (October 2008) we have a much lower bearish sentiment. That’s certainly to be expected, considering that the market has rallied from its recent low, but as I’ve repeatedly mentioned, the ideal situation is to see disbelief accompany such a rally. Instead, for the most part, we are seeing a normal reemergence of the status quo.

AAII
The retail investors, as measured by the weekly AAII survey showed less optimism with 39% bullish (a fall of 6% points). There was a 4 percentage points increase in pessimists to 42% bearish. This is certainly interesting and something that I’ve been watching for. That is, a decrease in bullishness after a rise in the stock market. The only problem is that considering everything else, I have trouble giving too much weight to this one particular data point.

Option Ratios
The options market continues to mystify me. Today, although the S&P 500 index (SPX) dropped 2% the CBOE (equity only) put call ratio barely moved. And the ISE Sentiment index (equities only) went up from 136 to 144.

Volatility
The CBOE volatility index strangely continues to defy gravity, staying within a 40ish range. Take a look at the very long term chart and it seems that previous resistance has become support at this level:

Rydex Ratio
The extreme sentiment that we saw at the beginning of March translated itself to a very spooked Rydex ratio:

And although we have since recovered sharply, Rydex traders are suddenly eschewing the short side in a big way. Money has flowed out of the inverse funds in such a hurry that their asset levels are at multi-year extremes. This just goes to show, once again, that the average market participant has quickly renewed their appetite for risk and jumped on the rally bandwagon.

If you were smart (or lucky) enough to ride this rocket of a rally, it is time to pare back positions and prepare for a possible less-than-dignified landing.

Magazine Cover
Here’s an interesting dichotomy. Time magazine’s cover this week for the US market is pretty tame: The End of Excess with the image of a reset button.

But take a look at the international edition: All Together Now. And the accompanying image being a boat going over a massive waterfall!

Not sure what that portends. I’ve never seen different covers like this. Any ideas?

Apologies for the delay, I’ve been trying to keep up with this fakakta market. Here is this past week’s sentiment overview:

Sentiment Surveys
The AAII survey for this week showed only 33.33% being optimistic (bulls), and again, a whopping 55% thinking that the market is going to continue to go down. If you recall, historically, anything above 50% bearish sentiment is very significant. However, sentiment in a bear market is different than that in a bull market. So adjust your lenses accordingly.

The sentiment survey of Investor’s Intelligence by ChartCraft showed only 33.7% bulls and 47.2% bears (with the rest sitting on the fence).

Before we leave surveyland, it is important to note that something has truly scared the average American investor because not only are they very pessimistic as described above, they are now positioning their portfolios so defensively, it has only happened a few rare times. They are holding a +35% in cash, only 51% equities and the rest in bonds. The last time we saw a lower equity allocation for these guys was way back in the throes of the last bear market (late 2002) where it reached into the 40’s.

Options Continue to Confuse
On Friday, as the market continued to bleed, the ISEE sentiment ratio came in at 119, meaning that retail option traders were comfortably buying more calls to open positions than puts!

And the CBOE put call ratio (equity only) came in at an anemic 0.79!

So the options markets continue to confuse the heck out of everyone. I’ve read as much as I could find about it but either people are scrambling valiantly to explain it with outlandish theories or they are outright ignoring it.

The best alternative theory I’ve heard put forward is from Barron’s:

I mentioned sentiment being fearful earlier and certainly the Chicago Board Options Exchange volatility index, aka the VIX, registered some extremely high readings this week. Dubbed the “fear index,” when the VIX reaches extreme highs it often marks a bottom of some kind.
Finally, something for the bull column.
But can we truly believe the VIX, which is based on options premiums? After all, investors are no longer allowed to sell more than 1000 stocks short thanks to a temporary ban. One of the few places to hedge a portfolio is in the options market, and that may be changing the VIX in ways we just cannot know at this point.
Anecdotally, I don’t see the “get me out at any price” fear in the mainstream and financial media. Investors are fearful, but I don’t think they are truly as panicked as we might believe.
So, the scales seem to be tipped for the bears, keeping capital preservation tops on my list of investment activities. The final word from Washington could change things in a hurry, but from the technical evidence we have, this bear market is not over.

The What Spread?
This is truly scary. The TED spread continues to go up. The what spread? Yeah, that’s what a lot of people are wondering too. Take a look at the chart showing the trend of this search query in google’s search engine (worldwide). At the beginning of September, things go bonkers:

The reason I say scary is that it is creeping higher rather than spiking higher. That makes it difficult to know whether the trend has exhausted itself.

Magazine Covers
A qualitative contrarian sentiment guide is the magazine cover. Ideally, it will be tremendously pessimistic and have wide, general public circulation. This week, the only one fits the bill is the Time magazine cover of the 1929 soup line with the title: “The New Hard Times”.

The Economist and Forbes are arguably specialty magazines but their most recent editions’ covers are pessimistic as well. Although, the Forbes one does show the chart going up towards the end. And the article that corresponds with the cover, also hits some optimistic notes, mentioning the large amount of cash on the sidelines (more details on the cash cushion here). So, as pessimistic covers go, it doesn’t really qualify fully.

The magazine cover indicator is a great contrarian sentiment measure because once a topic has reached massive public penetration and put on the front cover of a magazine, the trend is about to finish.

But once in a while we get conflicting covers. And in such a case, the question then is, which one is right? which one do we fade?

A recent example is the cover of Time and the Economist in the summer of 2005. They both came out within days of each other and had very different views of the housing market:

After the Fall
The symbolism of the brick in free fall left no doubt what stance The Economist was taking on this issue. Although housing prices were going up like there was no tomorrow, the Economist was asking about what would happen after the inevitable fall.

I remember reading this while in Europe because I could see first hand the freakish gains in real estate and the avarice that it had fueled over there. Published: June 18th, 2005

Home $weet Home
Now contrast that with the cover on Time showing a man happily squeezing a house in a bear hug. Note the $ instead of “S”weet and the taglines: We’re going gaga over real estate, Will your house make you rich?, Super hot markets, It is time to buy-or sell?, The case for renting.
Published: June 13th, 2005

For some perspective, here’s a chart of the housing bubble (superimposed on that of the internet bubble gone by):

Source: InvesTech’s Housing Index is proprietary composite of the most sensitive stocks in the housing sector.

So which one of those covers should you have listened to?

Obviously The Economist. I myself tried in vain to point out the danger of such a hyper-inflated bubble to a relative who was heavily invested in European real estate. I was given a laundry list of why the argument in the Economist article didn’t matter or was wrong.

But why?

Not because one magazine is inherently better but because one magazine (Time) is geared to a more general audience while the other (The Economist) is targeting a very discerning readership. Plus, if you had read both articles, you couldn’t have noticed that Time’s was simply “fluff” while the Economist one was bursting at the seams with data and more data.

My point is this: to get a really good contrarian cover indicator, look for the most general audience publisher. Don’t go for specialty publications.

The full Economist article (minus tables and graphs) after the jump:

Continue reading ‘When Magazine Cover Indicators Clash’