Here is this week’s summary of sentiment data for the market:
The weekly AAII survey from US retail investors shows a slight uptick in optimism. Those expecting higher prices in the next 6 months increased to 41.4%. The bears also fell - down to 28.6% - bringing the bull ratio to 59%. During the past few years we’ve seen the market crest when the bull ratio reaches 68% (that is the ratio of bulls to the total of bulls and bears). We are still quite a ways from that level so the AAII survey is still not giving the longs something to be concerned about.
The only worrisome development one may point to is that while the S&P 500 stayed basically flat (at ~1209) between the time of the previous survey and this week’s survey, we are seeing bullishness increase from 38.2% to 41.4% (as well as the bull ratio from 53% to 59%). This doesn’t take into account the effect of Friday’s market selloff which could persuade the AAII members to rein in their optimism. We’ll see how things develop next week but for now, I’m not too concerned about this.
The latest Investors Intelligence survey from ChartCraft showed the bullish camp rising to 54.0% from 53.3%. The bears are at 18% (a slight decrease from 17.4%). This is the largest portion of bulls from the II survey since early 2008. As well, the bull ratio this week is 3:1 for the second consecutive week - a level which has in the past corresponded with market tops.
The Hulbert Newsletter Sentiment Survey is showing a similar air of exuberance, especially among Nasdaq market timers. According to Mark Hulbert, these newsletters are recommending their clients to have a 80% net long exposure to the Nasdaq. That is not only an incredibly fast change of heart from just a few months ago but it is also the highest level of enthusiasm going back to the 2000 when these same newsletters suggested an exposure of 90% for a few weeks during the month of July 2000.
The all time record is held by one single day: April 4rd 2000 at an astonishing +114.3% - when they were suggesting their clients go long with leverage, to disastrous ends. While it is no secret that the technology sector has been leading the general market with a very strong relative strength, this as well as the next sentiment measure would suggest that, at least in the short term, it would be smart to take cash off the table.
Smart strategists like Jeremy Grantham are staring to wonder aloud about the rampant speculative forces and whether we have yet another bubble forming. As he explains, traders are compelled to play with fire because of the Fed. When there is free money to be had, it is normal to find capital rushing in.
Like a Pavlovian dog, Rydex timers have been trained by the combination of repeated and profitable “buy the dips” lessons during this cycle and the relative strength of the Nasdaq. We find them taking an increasingly aggressive stance, upping the stakes each time. Most recently they have invested more than 4 times the money in the leveraged Nasdaq 100 index fund than in the leverage Nasdaq 100 short:
Source: Tick Tock in Tech
The last and only time this ratio was higher than 4:1 was in early January of this year - just as the market formed a top. It is difficult to gauge whether the ratio will hold here or if it will be pushed higher as it has been for the past year. In either case, there is no question that we are seeing an extreme level of complacency by these market timers.
Mutual Fund Flows
We’ve already covered the trends in mutual fund flows so I won’t repeat them. The fascination of US retail investors with bonds continued in April, although we’ll have to wait until the last week’s data is tallied. For the three weeks that we do have data, there was an inflow of $18.5 billion into bond funds. That isn’t surprising as it is inline with the observed trend.
The somewhat surprising development was to see a $5 billion inflow into domestic US mutual funds. Before we read too much into this, keep in mind that this isn’t for the whole month and it is only one data point if it were. We’ve seen these blips before. For example, in January of this year and June and July of last year. For the moment, I’m not seeing any change in the preference of fixed income versus equities. And considering where we are in the interest rate cycle, the retail investor is once again poised for catastrophic disappointment.
According to ICI US mutual funds in aggregate, are holding the smallest relative amount of cash on record. Cash levels are lower than the 2007 market top and even the 2000 bubble top. I’m sure that the bears will have a field day with this. After all, what is more bearish than cocksure mutual fund managers who have pushed all their chips onto the table?
But before you interpret the lack of a cash buffer as bearish, keep in mind where we are in the monetary cycle. With interest rates at basically zero, there is no incentive to hold cash - that is exactly what Bernanke & Co. want of course. Do something with the cash, spend it, invest it, speculate with it - just don’t save it for heaven’s sake!
According to original research by Norman Fosback in 1976 and later independently confirmed by Jason Goepfert’s work, we know that the interest rate environment does matter when it comes to mutual fund cash levels. So when we take into account the disincentive for holding cash, the current level isn’t that extremely bearish.
Also, keep in mind that this ratio is affected not only by the rising equity values but also by the restricted supply of cash into equity mutual funds during this cycle. So with both the denominator rising and the numerator weak, it isn’t surprising to see the result languish at all time highs.
While the sovereign debt downgrade and potential default in Europe has grabbed headlines and even moved equity markets around the world, the high yield bond market is unaffected. We’re continuing to see a robust demand for junk bonds and to satiate the demand companies are rushing to sell their bonds. According to this recent Bloomberg article, global high yield bonds brought in $7.23 billion this week and $10.2 billion last week. As one analyst puts it, “The high-yield market seems to be trading in its own parallel universe”. Further sign of froth?
The option traders have mellowed out a bit and are no longer willing to sell their first-born for a call option. But even though they are coming down to more reasonable levels, make no mistake, this is a very very bullish position:
According to trading on the ISE, for the past 2 weeks, retail option traders bought on average 204 calls per 100 puts. Even the sharp drop on Tuesday - the largest single day drop for some time - didn’t really scare them. On that day, they still bought 183 calls for every 100 puts.
The CBOE option market confirms this. The CBOE’s equity only put call ratio (10 day moving average) is only 0.517. While that is slightly better since it bottomed out at 0.446 in mid April, it is still indicating an inordinate amount of enthusiasm for the long side:
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