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I wish all of you a happy, prosperous and healthy new year! Fittingly, his week’s sentiment overview straddles the old and new year:
Both of the popular weekly sentiment surveys are in agreement showing an extremely bullish mood, which should make any contrarian stand up and take notice. It now stands two standard deviations below its 1 year average. The AAII weekly sentiment survey of retail investors in the US has only 23% bears and a whopping 49% bulls. The AAII ratio hasn’t been this lopsided since May 2008 when the S&P 500 topped out at 1440:
Source: Elliott Wave - Short Term Update
Similarly, the Investors Intelligence survey of newsletter editors has plumbed new depths from last week and reached a new record. We haven’t seen this few bears in 22 years! The II finished off the year with only 15.6% of editors looking forward to lower stock market prices and 51.1% optimistically looking forward to the continuation of the rally.
The keepers of the Investors Intelligence survey, Mike Burke and John Gray, believe that while “some additional gains may occur in the near term, stocks may peak in the first quarter of next year and correct from there.” Smoothing out the weekly results with a 10 week average of the bulls divided by the bulls and bears shows that the market is overbought by 71% - the last time it was at similar lofty levels was back in late July 2007. Here’s another chart showing just the Investors Intelligence survey compared to the S&P 100 index:
Source: Schaeffer’s Research
Crash Confidence Index
Checking in with this lesser known sentiment indicator, we find 31% of individuals and 30% of institutional investors confident that there will be no stock market crash in the next 6 months.
Technically, the question the respondents answer is whether “the probability of a catastrophic stock market crash in the US, like that of October 28, 1929 or October 19, 1987″ is less than 10%. So the higher the Crash Confidence Index, the less likely a crash is perceived to be possible in the near future and therefore, the more bullish the sentiment.
Source: Yale Center for Finance
Keeping in mind that we’ve just had a 50% retracement for major stock market indexes, I’m surprised at how low (and therefore bearish) the current numbers are. This metric isn’t flagging a lot of bullishness either on the part of individual or institutional investors. Especially compared to how optimistic the index was back in February 2007 institutional investors were 57% and individuals were 48% in April 2006.
The latest survey of consumer sentiment by the Conference Board shows that while consumers are hopeful for a better tomorrow, they are very, very pessimistic about their present day predicament. For December, the Consumer Sentiment rose to a 3 month high: 52.9 but the present situations index fell to a 26 year low of 18.8.
While I sympathies with the difficulties that many are going through now, stepping back and gaining a long term perspective offers us another view. Periods of widespread and extreme pessimism usually correspond with inflection points in history. That has been true for major elements of society and the economy as well as the stock market. Take a look at this long term chart showing the number of Americans who are satisfied with the direction of their country:
As you can see, periods that correspond to despondence and pessimism were actually fantastic buy opportunities in the market: early 1980’s, 1992, 1996 and early 2009. It is easy to lose sight of the perspective that history provides and get carried away with the zeitgeist of the moment. Being a true contrarian is very difficult, not just because it demands that one correctly identify the prevailing trends and find points of extreme but also because it requires that one have the mental and emotional fortitude to go against the crowd and “stand alone”.
Mutual Fund Flows
Let’s leave aside what investors are saying and let’s look at what they are actually doing. According to EPFR Global, US retail investors added $11.1 billion to equity mutual funds for third week of December. That is the highest amount in 79 weeks (June 2008) but it hardly offsets the massive outflows we’ve seen during the past year. An additional $2.2 billion went into foreign equity funds and $4 billion into bond funds ($2 billion foreign and $1.7 billion US bonds).
Since I’m not familiar with the methodology EPRF Global uses, I’d prefer to get confirmation from the Investment Company Institute (ICI) fund flows data. In any case, it would take a massive and unmistakable move to reverse the fund flows which have seen investors flock to fixed income and ignore equities in 2009. The latest data from ICI isn’t showing that.
The herd like behavior of Rydex traders as they rush in and out of the market to try and benefit from trends is telling us that they are way too optimistic right now (they are heavily betting on the long Rydex funds).
There isn’t much new to report about the option sentiment. Both institutional and retail option traders continue to unequivocally favor calls instead of puts as they have for the past month. Part of this could be explained away by the positive seasonality for the end of the year. But the sheer extreme numbers are hard to wave aside as they have presented a formidable obstacle for the bulls in the past.
Lowry Research Proprietary Indicators
While this isn’t a sentiment indicator per se, I wanted to include it to balance the big picture. Lowry is the oldest technical analysis firm on Wall Street and their proprietary indicators of buying power and selling pressure have been their client’s guides for decades. The last time we checked in on them, Lowry Research recognized the ‘tiredness’ of the rally but was still bullish. Right now their measure of investor demand is at a surprisingly high level (last seen in October 2009). Meanwhile, the selling pressure index which measures the supply in the stock market is making new lows.
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