Trader’s Narrative

Here is this week’s stock market sentiment overview:

Sentiment Surveys
In last week’s sentiment overview, ChartCraft’s Investor’s Intelligence sentiment survey came in at a 14 year low (for bullishness). This week there were only 22.4% bulls with bearishness remaining unchanged. This week’s numbers take the II to a 20 year record! From a contrarian point of view, the message is clear.

The AAII sentiment survey is whistling a different tune however. The bears fell dramatically from 61% to 40% and the bulls rose to 41%. That’s a dramatic shift. Not only for the decrease in bears but because technically we now have slightly more optimists than pessimists. For confirmation of a market bottom and a healthy rally, I’d prefer to see continued doom and gloom.

There was a similar uplift in mood for the Consensus sentiment survey. Bullish sentiment rose from last week’s 21% to 36%. Again, not the sort of thing that gives contrarians confidence for a sustainable rally.

Volatility
Now this is just insane. The VIX closed the week at 70.33 - that is a record, in case you’re keeping track. But a new all time high record isn’t what makes my eyebrows levitate. It is that the VIX ended higher than on October 10th 2008 - when the market closed lower than on Friday. So while the market is now higher, fear - as measured by the VIX - is actually more pronounced. Interesting.

TED Spread & LIBOR
The credit markets are continuing to thaw with both LIBOR and the TED spread falling. But, and that is a big but, we are no where near normalcy. Both indicators are at extremely elevated levels. They difference is that they are now going in the “right” direction (if you are a bull). But they still have a long ways to go to totally unwind.

Sell Side Indicator
The Sell-Side indicator measures the equity allocation recommendation of the average Wall St. strategist to their clients. As you can imagine, as a group they are a great contrarian indicator just like the newsletter editors (Investor’s Intelligence) or the retail investors (AAII). Here’s a good article which explains it in more detail.

Right now the average allocation is 58% - which is the lowest level in 10 years. However, if you look back more than that, it is clear that we are near levels which would only suggest a cyclical bottom for the stock market, not a secular one (at best):

University of Michigan Sentiment Survey
If we needed another sign that the US consumer is totally pessimistic, the recent Michigan sentiment survey shows an even lower reading than the last time I mentioned it in May (Conditions of a New Bull Market: Consumer Sentiment). At 57.5%, it is now lower than anything we’ve seen in almost 30 years. This is saying a lot when you consider all the shocks that the financial markets have been buffeted with over that time:

The lowest reading in the history of the survey was in May 1980, 51.7%. This most recent result is preliminary and may be changed when it is finalized on October 31st 2008. We actually saw a lower reading than this most recent number in June 2008 with 56.4%. Then things seemed to improve to 70.3% only to fall down again. In any case, these small details matter less than the overall picture showing a shell-shocked consumer.

As you’d imagine, in the upside down world of contrarian sentiment, extremely pessimistic consumer sentiment is bullish.

Hedge Fund Redemptions
Forget mutual fund redemptions, hedge funds, the sophisticated investment vehicles of wealthy individuals and institutions is hemorrhaging assets to the tune of $210 billion. It seems most aren’t absolute return vehicles but closed index funds because in the recent quarter, they produced terrible results for their clients. According to hedge fund watchers, this looks to be the worst year both in terms of asset flows and returns.

Of course, not all hedge funds suffered. Andrew Lahde posted +860& returns and closed shop after just one year.

Here is this week’s sentiment summary:

Insider Selling
The bad news is that according to Argus Research, insiders selling pressure is now double what it was during the bottom in March. The good news is that it is still low enough to mean that insiders do not view the ensuing bounce as just a bear market rally. That gives you an idea of just how critical the March 2008 bottom was!

In mid-March, just as the market was trying to find footing, the sell to buy ratio hit 1:1. This is very rare since the long term average is just a tad above 2:1, meaning on a given week insiders sell 2 times as many shares as they buy. The last time this ratio was lower was in October 2002 when it reached 0.89:1.

Even better news, according to new research the “normal” level of selling to buying has been reset much higher due to the increasing allocation of ESOP as compensation for executives. Check out the book by Prof. Nejat Seyhun (University of Michigan) “Investment Intelligence from Insider Trading” for more.

Sentiment Surveys
There were no significant changes in the usual sentiment surveys I follow, namely AAII and Investor’s Intelligence, as bulls continue to outnumber the bears.

Investor’s Intelligence had 47.3% bulls and 30.8% bears while AAII had a similarly slight increase from 45% bulls to 46%. While optimism has the majority it isn’t anywhere near levels correspondent with major market tops.

ISEE Sentiment
This is rather odd. Usually when the market receives the kind of drubbing it got this week, option traders hurry to buy downside protection. But the reverse happened according to the ISE options data. The All Securities ISEE Sentiment Index actually went up from 117 to 140 on Friday.

This means that there were 140 calls bought (to open) for every put on the ISE platform. This isn’t the highest levels of optimism by any means. On October 8th it reached 187 and October 29th 192. But it isn’t just the absolute level of call to put buying that surprises me, it is the fact that it follows on a really bad week for the markets.

I’ve been cautious since mid April as indicator after indicator lined up against a strong continued rally. That caution seems to have been warranted as we’ve given up all the gains since. This latest ISEE data point is just one more that should keep any contrarian on guard.

CBOE Equity Only Put Call Ratio
In contrast to the ISEE Sentiment data, the CBOE equities only put call ratio went up during the week. Since it is the inverse with calls being the denominator of the ratio, this means that option traders, as measured by the CBOE became actually more cautious as the market fell.