Trader’s Narrative

The market correction that we’d been waiting for has finally started in earnest so let’s take a look at the sentiment data for this week:

AAII Survey
This week’s survey of US retail sentiment by the Association of American Individual Investors came in at 34% bullish (a drop of 7% points from last week) and an increase of bears to 42% (a 6% point increase). While the increased fear is normal after the kind of week we had, the ratio of the two remains neutral. Had the response been either muted or exaggerated, it would have been more interesting. At this point, it doesn’t really offer any edge.

Investors Intelligence
The latest Investors Intelligence poll from ChartCraft showed the bull share fall a smidgen to at 48.3%; the bear share also fell a hair to 22.5%. Only 29.2% believe a correction is due. The ratio of the bulls to bears is 2.15 - higher than it has been for months. It must be noted, though, that the survey was compiled on Tuesday before the losses later in the week. Next week’s survey will reflect the full decline.

Daily Sentiment Index
The Daily Sentiment Index remains in rarefied territory. The high levels we find the current DSI is extremely rare. In the 22 year history of this metric the DSI has been 87% or higher, only five times:

Continue reading ‘Sentiment Overview: Week Of October 30th, 2009′

Here is the sentiment wrap-up for a week that saw new yearly highs:

Dow 10,000
Yes, the Dow Jones reached and surpassed the magically round number 10,000. But in case you were too busy to count, this is for the 26th time it has done so in the past 10 years. So that means we’ve had about 10 years of zero returns (excluding dividends and inflation). Those specialty party hats the NYSE hands out are well worn by now and no one really knows what we’re supposed to be celebrating.

Sentiment Surveys
Turning out attention to the AAII weekly sentiment survey, we find a large jump in optimism among retail US investors. This week 47% are bullish - a jump of 12% points from last week. In contrast there are 34% bears (a drop of 7% points). Usually this survey gets my attention anytime a particular camp has majority. We’re not there yet, but this is mighty close.

While you will most likely interpret this lopsided survey result to be contrarian bearish, keep in mind that the previous time we saw the bullish ratio this high was a few months ago in July 2009. As the chart shows, the S&P 500 index shrugged off any suggestions of ‘too much optimism’ and barreled ahead gaining 150 points. If I were relying on just the AAII survey, ideally I’d like to wait for the bulls to get to 50% or more before being confident about it tripping up the market.

Investors Intelligence
While the AAII bulls took the reins this week, the weekly survey from ChartCraft measuring the stock newsletter editors sentiment has been dominated by the bulls for a few months now. This week was no exception as the Investors Intelligence indicator came in with 47.2% bulls and only 26.4% bears. So this isn’t all that helpful because while II has been stuck showing about twice as many bulls as bears, the market has continued to rise.

National Federation of Independent Business
The monthly NFIB survey results show September inched ahead at 88.8 - which is pretty unimpressive since it isn’t even higher than the results in May (88.9). As well, 6 of the 10 sub-components were either down or flat suggesting that the tiny improvement came from a narrow contribution.

The details of the NFIB survey show the huge disconnect between Wall St. which has enjoyed a 60% rally and an attitude of ‘back to business as usual’ (with bigger than ever bonuses) and Main St. which is still struggling with a very weak economy. Small US businesses are not ready to build up inventories, nor are they planning on expanding capex spending, nor are they hiring, nor are they expecting credit conditions to ease. Small business in America is referred to as the engine of the economy but it has been neglected while ‘too big to fail’ banks and investment houses become even bigger and received billions of dollars from the government.

Option Traders
The sentiment in the option pits continues to be very very bullish. While some of the penchant for calls can be attributed to the stock replacement strategy, I don’t think that explains enough to discount the alarming extent of the skew.

The ISE sentiment index (equity only) which exclusively measures retail option traders opening transactions spent 4 days out of the 5 trading days in this past week above 200. That was enough to take the 10 day moving average of the equity only call put ratio to 200.8 which is the highest since November 2007. For a chart, see the sentiment overview at the start of the month.

The CBOE (equity only) put call ratio is also showing a similar pattern of excessive call buying. Its 10 day simple moving average is 0.52 which is among the lowest levels for many years. In the following chart, you can see how the S&P 500 has responded when we’ve seen this much optimism:

This is by no means an exhaustive or quantitative study but it does show that while the equity markets can rise a bit in the face of such bullish option sentiment, sooner or later, it catches up with it. Either the market goes sideways or corrects sharply. Hmm… that sounds familiar.

Volatility
As an alert reader pointed out, the CBOE volatility index (VIX) is now scraping a bottom not seen since September 2008. In case you’ve blocked out that painful memory, that was just before the catastrophic waterfall decline which took the S&P 500 index down to a 6 handle. But from all the historical studies that I’ve seen, a low VIX doesn’t really mean anything, not in the way that a spike high denotes a panic bottom for equities. After going through some absolutely insane volatility we are once again returning to historically normal ranges so I don’t think there’s much edge here.

IPO Pipeline
The private equity groups are getting more and more of their holdings gussied up for public offerings. If you know how shrewd an investor these institutions are, you do not want to be on the other side of their average trade. After all, timing the market is pretty much all they do. They fund or take unloved companies private and then when the public sentiment is ripe, they sell them back again for a higher price.

In the following weeks, Fortress, KKR, Blackstone and Bain Capital will be bringing a half a dozen IPOs online. Unlike the traditional IPO where a company raises money for expansion, these are exits where the firms that took an opportunistic stake want to get their money back with a healthy return. Usually a healthy IPO market is a sign of a healthy equity market and only when it become excessive should we take a contrarian stance. But now, I’m watching the number of IPOs and the welcome they receive in the market as a gauge of the mood out there.

Today Charles from the Kirk Report hosted a chat with Jason Goepfert. Here is an excerpt in case you missed it:

Yesterday’s bad start didn’t do much to tell us about what the rest of the month may hold. It wasn’t a great sign, but the last three times the S&P lost 2% on the first day of a month, the rest of the month gave returns of +14.2%, +15.7% and +3.2%….

Yesterday, columnist Mark Hulbert penned a piece highlighting October’s penchant for high volatility…

But here’s the thing…when the S&P showed a positive return over the prior month, then the average daily change in October was only +0.60%. When the prior month was negative, then the average daily change in October was +1.24%. This is an enormous difference - the average October day after a bad September was more than twice as volatile as when it followed a positive September.

Seems to me that we could be in for less volatility than normal due to the tame market over the past couple of months, and yesterday didn’t change that.

The chat was opened up to questions:

So, stepping back a bit, in your “big picture” sentiment analysis, do you have any perspective on where we might be within it right now?

Hmm, I would say somewhere near “denial” and “returning confidence”. There are a lot of arguments on both sides, which all seem cogent, but based purely on how I view sentiment, we’re not yet at an optimistic extreme, but we’re well off the “aversion” levels too.

And regarding the tip off for the end of this rally:

The biggest test for me is always how the market reacts to short-term overbought/oversold extremes. Every time we’ve hit short-term oversold since March, the market has recovered very well. Now we’ve seen a pattern of lower highs and lower lows for the second time (early July was the first), and we’ve short-term oversold. If we can’t rally from conditions like this, it is a definite warning sign that there is eager selling pressure.

Jason also featured these two disparate charts which answer just how much speculative activity we are seeing and in what form:
Continue reading ‘Today’s Chat With Jason Goepfert & Charles Kirk’

Here is this week’s roundup of sentiment data for the stock market:

Sentiment Surveys
AAII slight increase in the bullish camp and an 11% decrease in the bearish camp to bring both to 38% with 24% left over as neutral. That leaves us with no real edge, again.

Last month I mentioned in this sentiment overview that the AAII asset allocation to bonds was at a historic extreme (at 25% of the portfolio). The new AAII asset allocation for bonds is 17%, down 8% points, which is still a tad on the high end but no longer extreme. The equity allocation notched up slightly to 54% and cash to 29%.

The Investors Intelligence sentiment data for this week twitched slightly but we have more or less the same picture as before. The bulls declines slightly to 50.6% and the bears increased from their historic low to a more normal 24.1%. Of course, the bulls continue to dominate and the bull to bear ratio is once again above 2.

The Daily Sentiment Index from Jake Bernstein continues to show a rather frothy mood on the street. This week it was still at the elevated levels from last week (88%) while the Nasdaq futures traders were equally optimistic at 87%:

Citigroup Economic Surprise Index
Unemployment inched closer to 10% with today’s announcement of 216,000 jobs lost in August. But it is rarely the data itself that is important. Much more important is how it is interpreted and how the market reacts to it. And believe it or not, there is an index for that. The Citigroup Economic Surprise index measures whether economic data are better or worse than expectations.

When we have a streak of really good economic news, being human, we become acclimated to this new environment and come to expect further good news, discounting what once might have been actually very good news. Of course, a streak can’t continue forever and we become ‘disappointed’ by less than stellar news. In any case, right now the Citigroup Economic Surprise index is at its highest historical range. This means it is more and more difficult to wow the market with good news. Not surprisingly, in the past this has accompanied market tops.

Volatility
Volatility, as measured by the CBOE VIX index continues to be mired in the ~25 range which is the new support (previously resistance in 207 and 2008). Either a decisive break to the 20 range or higher to break the declining trend (above 30) would make me sit up and take notice. Until then it is boring me.

Reverse Stock Splits
Thanks to this brutal bear market we have heaps of previously well to do stocks which are now trading below $5. That is a significant line in the sand because most institutional managers have a mandate to only touch equities above that threshold. This is to protect investors from speculative issues like penny stocks. Rather than let their stocks scrape the bottom of the exchange, most corporations fall back on a sleight of hand trick called reverse stock splits to magically raise themselves above that institutional $5 level.

While it may seem to be a transparent trick, you may think it would be lucrative because it would allow institutions to once again have access to the stock in question. However, a recent study from Credit Suisse by Sveinn Palsson shows that since 1980, a reverse stock split does not raise the stock’s price. Instead, the median one month return after the corporate action is actually negative.

Today previous stalwarts are lining up to file reverse splits with the SEC. AIG did one in July. Citigroup filed just recently. And the list of sub $5 stocks goes around the block: CIT Group (CIT), E-Trade (ETFC), Huntington Bancshares (HBAN), Regions Financial (RF), Keycorp (KEY), etc.

Party Like It’s 1999
Here is a funny anecdotal sentiment observation. The design to the left is for a t-shirt website called threadless. This is a site where anyone can submit an original design and based on the votes it garners the staff pick about 10 designs every week.

In any case, this design is the ’sign of the horns’ - an ancient hand gesture which has different meanings depending on the era, location and culture. But basically, in this context, it is about exuberance, to put it politely. And it is mounted on top of the iconic Wall Street bull statue instead of its head. Somebody is partying like its 1999.

Hmm… that reminds me, where was it I saw trading t-shirts?

The chart below is from James Montier. It shows the average holding period for NYSE stocks (expressed in years) from 1920 to today.

Montier is an economist and global strategist who uses behavioral finance to make sense of the financial markets. He started his career at Dresdner Kleinwort, moved to SocGen and just recently moved to the hedge fund world. Montier has written several books, among them, Behavioural Investing: A Practitioners Guide to Applying Behavioural Finance.

I’m not sure where exactly Montier got the raw data for this graph but considering the caliber of research he does, I’m assuming it is an accurate reflection of the underlying change in the structure of the market over time. The chart is remarkable in setting out what we all intuitively know to be true. Driven mostly by high frequency trading, we’ve seen an explosion in advance decline volatility.

It seems I was wrong, when I said this isn’t your grandfather’s stock market. This is exactly your grandfather’s stock market. Indeed, your grandparents would readily recognize the sort of stock market we’ve had recently. What I should have said is this is not your father’s stock market (1950’s - 1960’s) where people actually invested by holding stocks for years at a time. In comparison, what we do now is push buttons with the attention span of a housefly:

Source: James Montier formerly of Société Générale

It is absolutely remarkable to notice that the turnover in 1929 - a time where trading was done over telegraphed message or scribbled notes and hand gestures - is equivalent to recent times when trading is done by blazing fast computers interconnected directly via FIX to the exchange.

If you enjoyed this, don’t miss Montier’s brutal take down of EMH (via John Mauldin’s Investor Insights). Also, in a world where we are all traders, the least we can do is be better traders:

• Why do traders fail?
• How to Fail as a Trader in 10 Easy Steps
• Dennis Gartmen’s Rules of Trading
• The Definitive Guide to Trading Mastery & Success
• 5 Fatal Flaws of Trading