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It is the end of the week and so we take a stroll through the sentiment meadows:
This week the ChartCraft measure of stock newsletter editors sentiment was little changed from last week: 49.5% bullish and 23.1% bearish. That’s another week where twice as many are optimistic that the stock market will continue to rise. A remarkable long string of weeks but so far they have been correct.
The US retail investors meanwhile, as measured by the weekly AAII sentiment poll are slightly less confident. There was a 6% point fall to 41% bullish. And the opposing camp increased a smidgen to 36% bearish. All in all, this metric is slightly elevated towards too much optimism but still not enough to warrant our full attention.
Hulbert Stock Newsletter Sentiment
The Hulbert Stock Newsletter Sentiment Index (HSNSI) which measures a subset of newsletters which try to time the market continues to be muted. For the most part the HSNSI is showing skepticism in the face of the continuing rally. The HSNSI is about as bullish as it was back in April 2009 when the S&P 500 was trading at 800 - some 280 points lower. That is to say the average market exposure recommended by market timing newsletter is only 32.3% (long) - slightly lower (by 2.3% points) than what they were recommending 6 months ago. Such an unflappably consistent skepticism in the face of a gravity defying rally hardly gives the bears much ammunition.
The preliminary October results for the Reuters/University of Michigan consumer sentiment index fell to 69.4 (significantly lower than the consensus estimate at 73.4):
During economic contractions, the average Michigan consumer sentiment is 74. The average during economic expansions is 91. And on average when the S&P 500 has rallied 60% from a recessionary low, this consumer sentiment reading is 90.5. These historical patterns offer a remarkable contrast to where we are today - especially if we consider the often repeated mantra that we are in full blown recovery mode.
The 10 day simple average of the ISE sentiment index (equity only) call put ratio has an enviable track record - in the intermediate time frame. Almost every time it has reached 200, the stock market has meandered then stumbled. Not at all surprising since this implies that for the past 10 trading days, relative to puts, more than twice the number of calls have been purchased to open an options trade. Not once has the stock market been able to muster a significant rally when we’ve seen this metric reach such an extreme reading.
So it is important to sit up and take notice as this week the 10 day average for the equity only call put ratio floated up to 200 and on Thursday hit 202. During the relative short history for this sentiment metric, here are the few times where it has been above this mark:
The first was at the start of 2006 - the S&P 500 plateaued then fell into the summer. It wasn’t until September 2006 that it had reached a new high for the year.
The next instance was late in 2006. This was not the best signal since the market did manage to continue to climb momentarily. By March 2007 the S&P 500 was back at the same level.
Then it was May and October 2007 when the ISE’s 10 day average again touched 200. During that time frame the market did manage to push against the tide but over all it went nowhere. And we all know what happened after that.
CBOE Put Call Ratio
In contrast, the CBOE put call ratio (equity only) has recovered smartly from the call buying frenzy that we witnessed last week. Although we’re seeing the bulls reign in some of their enthusiasm for calls, it is important to note that from a long term perspective, we are still seeing a preponderance of hope and optimism rule the option pits:
Last month we looked at the remarkable trend in fund flows for US retail mutual fund investors where even after a 60% rally in the S&P 500, the love affair with bonds continues at the expense of equity mutual funds.
Since then the same trend has more or less continued. Bond funds are still getting the majority of investors money but this week the ICI estimates they only got $8.80 billion (while last week it was almost double that at inflows of $15.21 billion). Equity outflows meanwhile have ameliorated with an estimated $3.39 billion being withdrawn for the week. This is down by about $1 billion from last week.
While a portion of this trend can be explained by the massive number of retail investors who are approaching retirement age, I can’t believe that that is the whole story. This bear market left a traumatic and indelible mark on those who lived through it, either as traders, investors, professionals or mere mortals. If this is true, then going forward, this means that we have to be very careful in how we calibrate our most trusted sentiment gauges.
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