There is a lot of material to cover in this week’s stock market sentiment summary, so let’s get started:
According to the weekly retail investor AAII survey, 29% of respondents are bullish - a tiny increase from last week. Meanwhile, 47% of respondents expect the market to decline going forward - an increase of 8% points.
More interestingly, the AAII asset allocation to equities continues to increase. The last time we looked at this in early May 2009, it had recovered from the abysmal level of 41% - the lowest on record. Now it is at 57% with most of the increase coming from a reduction in cash holdings which were at one point the highest on record at 45%.
While as a contrarian the ideal situation would be a continued pessimism (low asset allocation to equities), this isn’t really realistic. It is normal for people’s expectations to be recalibrated once the shock of a system wide meltdown recedes. And we also need for an orderly march towards optimism if the market is going to recover. That is the only way that new money will flow into equity markets and by increasing demand, drive up prices. We are far from extremes of 70% allocation that would provide cautionary signs. So it is a good sign that we are seeing growing optimism from this indicator.
ChartCraft’s weekly Investors Intelligence measure of newsletter editor’s sentiment is - oddly enough - split exactly down the middle: 35.6% bears and 35.6% bulls. Although this is rare, the more important thing is that this is a continuation of a short term trend in the increase of those pessimistic about future market prices and a decrease in those optimistic. Not long ago the bulls outnumbered the bears 2:1 but now, they are the same.
The Hulbert Stock Newsletter Sentiment Index, which tracks a small group of newsletters which try to time the market, is 15% points lower now than it was in early June. For those that time the Nasdaq, the mood is even gloomier: 27% points lower today than in June.
When you consider that almost all indexes are now trading slightly above last month’s highest levels, this gives new life to the spring rally. This is because while the recent decline spooked the average market timer enough to reign in their horns, the following sharp rally which made up for those losses did not made them rejoin the bullish camp. This reticence to become optimistic once again in the face of higher prices is bullish from a contrarian viewpoint.
While Wall Street strategists may get paid much more than the average retail investor, their prognostications have, on average, equal dependability - which is to say, not much. Just as the retail investors were fleeing from the bear market by reducing equity allocation and building cash and fixed income levels, the Wall Street strategists were also doing the same. In fact, their lowest level of equity allocation since 1997 coincided with the March 2009 low. And once again, in lockstep with their retail strategists, they’ve upped their equity allocation slightly in response to the higher stock market prices.
The Bloomberg Professional Confidence survey for US equities fell to 39.56 - its lowest level since March 2009. Any reading below 50 implies that respondents expect lower prices ahead for the Standard & Poors 500 index. This was the second consecutive monthly drop since it reached a high of 51.6 in May 2009. So while optimism increased in line with higher prices, the subsequent range bound and choppy trading caused many to abandon that position and take defensive postures. This general mood is also confirmed by a separate study by Merrill Lynch which suggested that large institutional money managers were ‘underweight’ the US equity markets. The majority cut their exposure to US markets in July 2009.
Rydex Sector Funds
According to Jason Goepfert, the Rydex Sector investors have rushed out of equities giving a contrarian signal. Rydex Sector funds are used by aggressive position traders and investors to gain exposure to specific parts of the wider stock market, much like sector ETFs. Among the myriad statistical measures that Goepfert keeps track of is the percentage of the Rydex Sector funds which have assets above their 50 day moving average. The rationale is that when itchy trigger fingered market timers are bullish, they buy into these high beta funds to ride the market higher. But when they get scared, they sell and retreat into money market funds, sending the Rydex Sector assets tumbling.
As all contrarian indicators, Rydex Sector investors are wrong as a group. So historically, when very few of the Rydex Sector funds has assets above its 50 day moving average, it has indicated that there is enough fear to induce higher prices. Right now, we aren’t yet at previous extreme levels but we’re very close.
The CBOE put call ratio (equity only) dropped to just 0.58 - which means that calls were bought about twice as much as puts. Just a few days ago, at the beginning of the month this ratio was 0.86 as moderate fear of a market drop was the prevailing mood in the options exchange.
The options sentiment on the ISE mirrored the same changing mood as the call put ratio (equity only) reached 184 - meaning that 184 calls were bought for every 100 puts. However, since the 10 day moving average which smoothes out the short term volatility is mired in neutral, we do not have a defining signal from this indicator.
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