Here is this week’s summary of sentiment data for the stock market:
The weekly survey of retail US investors from AAII shows the bulls decreased from 49% to 41% and the bears increased slightly from 23% to 26%. While this is an amelioration of the extreme reading from last week, it is still quite elevated.
There is a peculiar disconnect between this quantitative measure and more anecdotal evidence of sentiment. For example, there are stories like this (pointed out by a reader) all over the media which shows the average US investor far too distrustful of the stock market and happy to seek sanctuary in bonds, as they have for most of last year.
But what is most interesting this week from the AAII survey is not the sentiment data but the shift in asset allocation. Amazingly, the average AAII investor increased their exposure to the stock market by +15% points to 64%. That is the highest level since, you guessed it, October 2007. The rest is equally divided between cash and bonds.
This week’s survey of newsletter editors’ sentiment from ChartCraft shows a slightly less optimistic bunch: 48.3% bullish, 16.9% bearish and 34.8% awaiting a correction. While the Investors Intelligence numbers have backed off the eye-popping, record-breaking levels we saw in last week’s sentiment overview, this is still most definitely extreme. After all, we still have about a 3:1 ratio of bulls to bears.
Checking in with Market Vane’s bullish consensus we find that it has moved up to 57%, almost as high as in September 2007 when the stock market was about to peak. At the March 2009 lows, in contrast, bullish consensus was at 32%.
This week the traditional option sentiment measures finally reflected the extreme bullishness that we’ve been seeing elsewhere. The short term average of the CBOE (equity only) put call ratio fell to 0.564 - basically meaning that for the week option traders were buying twice as many calls as puts:
This is about the same level of optimism that we last saw in mid-Sept and mid-October of last year when the market topped out momentarily. It also coincides with the market top in October 2007. All in all, it has been more than 5 consecutive months that option traders have shown absolutely no fear whatsoever.
The ISE Sentiment index which tracks retail option traders is also showing the same picture. The ISE is a ratio of puts to call so in the chart below, you’ll see a sharp spike up that reflects the current penchant of option traders in buying calls vs. puts:
At the end of the week, the 10 day moving average of the equity only ISE Sentiment index stands at 191 - which again, implies that traders are preferring calls to puts by a 2:1 margin. This same ratio was slightly higher (202) in late October 2009. Also note that similar to the CBOE put call ratio, for the past few months we’ve seen the majority of daily ratios slightly above 150. Still, the ISE ratio is not at levels that correspond to the October highs in the stock market.
The CBOE volatility index (VIX) fell to just above 18 this week. It has been in a downward trajectory since spiking to historic highs in late 2008. The next support level is 16 (where it bounced off last on May 2008 and October 2007). Yes, once again, we are seeing a metric return to October 2007 levels. But watch for a knee-jerk reaction. Extreme highs in the VIX correspond to stock market lows but extreme lows do not have any real edge since they do not correspond to stock market tops.
A partial explanation for the persistent decline in the VIX is the covered call strategy adopted by many investors. While the retail investor crowd who adopts this strategy to gain a bond-like yield from their equity portfolio is not large enough to make such an impact, they do have institutional equivalents. The last time we saw the VIX fall into a funk like this was back in 2003 and 2004 when the Fed funds rate was at historic lows (although slightly higher than it is now):
Again, I’m not sure if this is a full explanation but it is something to consider. There is always a portion of the investment community that requires yields and when interest rates are this low, selling covered calls suddenly becomes very popular as there are no viable alternatives. The basic laws of supply and demand take over as the sale of calls (and puts) pushes down their prices and therefore, volatility.
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