Trader’s Narrative

In case you missed it, there was a cornucopia of charts covering sentiment yesterday when I summarized the fantastic webinar given by Jason Goepfert of SentimenTrader (and hosted by Fari Hamzei of Hamzei Analytics). So rather than repost the charts here, I’ll just refer you to that yesterday’s summary. As well as a multitude of charts covering everything from sentiment surveys to options to insider transactions, it will provide you with the broader context.

The following sentiment summary for this shortened week will provide a more granular picture

Sentiment Surveys
The American Association of Individual Investors’ weekly sentiment survey came in with slightly less ebullience: 40% bulls and 35% bears. We almost, almost, have parity between the two opposing camps which is a far cry from what we saw at the beginning of the year when there were twice as many bulls as bears.

Of course, the correction was already underway when the respondents sent in their answers (on Thursday). So that may have had something to do with it. And if the market continues to decline into next week, the natural tendency would be for the AAII bullish sentiment to shrink in sympathy.

In contrast, the Investors Intelligence sentiment survey shows a stubbornly bullish position by the average newsletter editor. This week there were 52.2% bulls and 18.9% bears. Those expecting a correction decreased slightly to 28.9%. But this tenacious bullish streak may simply be due to the timing. When the survey was taken (Wednesday) the stock market was still trading down but still nestled in a comfortable trading range. That changed with the two back to back wide range down days on Thursday and Friday.

The 10 day moving average of the ISE Sentiment index (equity only) has come off its nosebleed levels it was at during the start of this shortened week of trading. The peculiar thing is that on Friday January 15th, even though the S&P 500 (along with all major indexes) fell by 1.08%, the ISE call put ratio was 200 - implying that retail option traders were twice as eager for the possibility of further gains in stocks as buying insurance in case of their decline. But I suppose these sort of daily deviations are the noise that a short term average smooths out.

Merrill Lynch’s Fund Manager Survey
According to the January results from the ML Fund Managers Survey the appetite for risk is back. In fact, as you can see from the composite index it is equivalent to the early 2006 levels which has caused cash to dwindle as professional money managers rush into equities:

If Charles Biderman is curious where the money is coming from, he should look no further. According to the survey covering money managers responsible for $539 billion in assets a lot of cash has been thrown at the equities market. Especially the emerging markets.

While Obama’s “Volcker Rule” is being generally bandied about by the mainstream media as an explanation for the market’s fall, few are paid attention to China’s recent credit announcement and its effect on the commodity side of the market. In fact, commodities and commodity related stocks have fallen more than banks stocks. Which is bad news for the money managers in the Merrill Lynch survey who are once again overweight commodities:

But even more so than commodities, the majority (52%) of the more than 200 respondents were overweight equities, which is the highest level since July 2007. More alarmingly 55% have no downside protection (which isn’t all that surprising when we recall the options data). The survey covers January 8th to 14th 2010 just before the start of the correction underway now.

Options Sentiment
The ISE Sentiment index (10 day average) rose to 207.3 at the start of the week (Tuesday) but fell along with the market to finish at just 187.6. To find a time that it was at comparably lofty levels, we would have to go back to early November 2007 when it peaked at 213.2 and before that mid July 2007 when it reached (an all time high for the indicator of) 244.8. Currently we are back to the optimistic levels of the beginning of this month.

The 10 day moving average of the CBOE put call ratio (equity only) jumped to 0.6 as a result of the increase in option traders seeking downside protection. But we are still at an area of extreme optimism:

Again, for the bigger picture, see the option sentiment charts from yesterday’s webinar.