Trader’s Narrative

For those celebrating Christmas, I wish you and your family, a Merry Christmas. And if you’re not, I hope you enjoy your time off over the holidays. Here is the final sentiment overview for the year:

Sentiment Surveys
According to the AAII weekly survey 38% of US retail investors are bullish (that’s a small drop of 4% points from last week) and the same portion are bearish. So once again we have parity between the two camps. As you’ll recall, back in mid August we saw this metric reach an extreme of 50%. And even though the S&P 500 is now higher by 12% sentiment has backed off to more or less neutral.

The Investors Intelligence survey of newsletter editors in contrast is continuing to show a very lopsided mood with the bulls outnumbering the bears by 3 to 1 (52% to 17%). We’ve been monitoring the II at this level for more than a month now. The last time we saw things this bullish was back in late 2007 just as the bear market started.

Mutual Fund Flows
US mutual fund flows have been very strange this year. At the beginning of the year, as stock prices were being pummeled, both retail and institutional investors took refuge in money market funds, helping to balloon total assets to $2.904 billion (on March 11th 2009).

As the panic wore off both of them slowly withdrew their assets (each side by about $300 billion). However, most of the cash was diverted to the fixed income market, rather than the stock market as it had been in previous recoveries.

This trend became obvious by summer and it has continued right into the year end. Some contrarians interpret this to mean that there is a lot of skepticism out there, especially in the face of a 25-45% rally in the stock market. While this may be true, at some point the continuation of this trend ultimately will mean the end of the cyclical bull market because the participation of retail investors is a vital element.

Option Sentiment
The trend of excessive speculation in the option markets continues this week. The CBOE (equity only) put call ratio is showing a preference for call buying much more than the ISE Index (equity only). However, while the CBOE ratio has maintained its level from last week, it was the ISE index that moved up sharply as retail investors scooped up calls for a Santa Claus rally. The ISE 10 day moving average jumped from 163 to 181.

The mania sweeping the options markets is more obvious when we look at opening only transactions from data provided by the Options Clearing Corporation (OCC). Right now this measure is at a multi-year high signaling that investors are far too optimistic. And even more susprising, both institutional and retail option buyers are equally manic.

Magazine Cover
This week’s Business Week magazine cover story is about the investment outlook for the coming year.

The 3 questions on the cover: BUY? SELL? PRAY? don’t really lend themselves to providing much of a contrarian edge.

More than anything, such a cover is neutral to mildly pessimistic, which tells us that we don’t have an excessively bullish public mood for investments or the stock market.

You can read the cover article here - the main thesis is to invest outside of the US, especially in emerging markets.