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Sentiment Overview: Week Of October 8th, 2010 at Trader’s Narrative

Sentiment Surveys
Retail investors responded to the strength of the stock market this week by increasing their bullishness. The AAII retail investor survey showed 49% of respondents being optimistic about future gains and only 23.2% bracing for lower prices. This results in a bull ratio of 64% and is the third week out of the past four weeks that the bull ratio has been 64% or higher:
aaii bull ratio Oct 2010

Normally a slightly higher bullish sentiment (68%) corresponds to market tops but such a persistent condition of bullishness should be troubling.

Investors Intelligence
Stock newsletter editors also continued to increase their bullishness according to ChartCraft’s weekly survey of sentiment. This week the Investors Intelligence survey had the highest level of bulls (45.6%) since mid-May 2010 (47.2%). The bears increased slightly to 28.3% resulting in a bull ratio of 62%. This is elevated but significantly below the levels we saw in May 2010 (75%) when there were 56% bulls and just 18.7% bears.

NAAIM Survey of Sentiment
Active money managers surveyed by the NAAIM weekly poll show a similar increase in optimism. This week is the third consecutive increase in bullishness. This week’s mean NAAIM sentiment is 76.42% and the median 77.5%. Such an increase in long exposure isn’t that surprising when it is put in the context of a generally rising stock market. Managers rarely fight the trend but what we are interested in is extremes of sentiment and so far we aren’t seeing that. Below is a chart of the median NAAIM sentiment:

NAAIM survey of manager sentiment Oct 2010

We don’t have a very large data set for this sentiment indicator but from the available historical data, it is relatively rare to see a reading above +75%. This has only happened 16.6% of the time (or 32 times out of the total 223). The other notable fact is that we are seeing less disagreement within the survey results as more managers accept the ensuing rally.

Corporate Buybacks
buybacks of SP500 companies Oct 2010One of the biggest questions swirling in financial circles is over the massive corporate cash pile. While the debate is still raging over whether it is a positive or negative, it seems that the corporations have found a use for all that cash that has been burning a hole in their balance sheets.

Since we last broached the topic, total non-financial cash holdings have ballooned to $1.8 trillion. And year to date, $273 billion worth of buybacks has been announced by US public companies. With the bond market providing a seemingly infinite demand from retail and institutional investors, corporations are finding it irresistible to not issue new debt at rock bottom prices and either lock in cash for the future or to turn around and use the cash to buy back shares on the open market. The source and rationale of the stock market’s buoyancy has been a controversial topic, especially in light of the retail investor exodus. I don’t pretend that this source of demand for shares is enough to fully explain that question but it is a fact that can’t be ignored, especially as buybacks continue to ramp up every quarter.

Mutual Fund Flows
In spite of positive market performance, the existing trend of US retail investors exiting domestic equity mutual funds and flocking to fixed income funds continued with the final weekly data for September’s fund flows. US retail investors sold slightly more than $20 billion of equity funds and plowed $32.5 billion into both taxable and non-taxable (municipal) bond funds. Since 2007 US investors have shifted $283 billion out of US equity funds and moved heavily ($762 billion) into bonds. And the trend shows no signs of changing or even slowing down.

ici fund flows bond US equity Oct 2010

Within the bond market, high-yield debt has received positive inflows for the 5th straight week. Fixed income funds specializing in junk bonds received $366 million net inflows last week, according to Lipper FMI. The previous week the inflow was $566 million and since July this sector has received $7.9 billion in net inflows as investors reach for yield. The average high-yield bond price is now above 100 cents on the dollar. According to data from Dealogic, public companies are taking advantage of the seemingly insatiable demand with $190 billion worth of junk bonds having been sold so far in 2010, easily trumping the 12 month total for last year, $164 billion.

The market can ignore the corrosive effects of this asset shift in the short-term. But eventually, unless it reverts back to its historical normal state of positive inflows into equities, it will have negative repercussions. These won’t be limited to just a reduced long-term return from stocks. By rushing into bonds as they are, investors are ignorantly exposing themselves to duration and default risk. And they are shutting down the IPO market which is a vital mechanism within the financial ecosystem.

Option Sentiment
For the past few weeks the option sentiment picture has been rather hazy. While there has been a lukewarm bullish tendency, we haven’t seen the kind of intensity that we look for as a contrarian indicator. Until this week. According to the option trading data from the ISE, four of the five trading days this week showed more than twice as much call buying as put buying to initiate a position.

ISE sentiment 10 day moving average Oct 2010

That brought the 10 day moving average of the equity only call put ratio to 203 which is the highest it has been since April 30th. Granted, the ISE Sentiment index did reach into the stratosphere in April (the short term moving average peaked at 249 in mid-April). But reaching such thin air territory is extremely rare. Previous to that, we saw a similar call put ratio on January 19th, exactly before the S&P 500 index and the rest of the equity markets took a tumble. And prior to that, there was another example almost exactly a year ago in mid to late October 2009 - once again, a short-term top for the S&P 500 index.

The more traditional CBOE put call ratio is not providing a similar signal as it continues to be mired in neutral. The short term moving average for the CBOE put call ratio (equity only) is 0.593 - converted to the equivalent of call put ratio, it is 169. High, but not extreme enough to warrant a contrarian interpretation.

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9 Responses to “Sentiment Overview: Week Of October 8th, 2010”  

  1. 1 DoctoRx


    Nice review. What do you say to Rosenberg’s comment to this quote from your post:

    “By rushing into bonds as they are, investors are ignorantly exposing themselves to duration and default risk.”

    Rosie’s point is that US investors are early in the game of rebalancing. They (as am I) are aging, yet they are MUCH heavier in stocks than bonds. So whether or not they/we are ignorant, they are just the opposite of investors in the 1930s-50s and beyond, who were terrified of stocks and thus missed the great bull of the 1950s.

    What say you?

  2. 2 Tim

    This is looking at the relative performance of the SPX to TLT (20 yr bond) for all the data in stockcharts history.

    What I see is a very large vacuum between stock and bond performance, which should converge at some point. You notice that the relative performance seems to converge at tops and bottoms, and vacuums form that show discrepancy between how the stock market is behaving versus what the bond market is doing.

    We are looking at one of the biggest vacuums in US history. I’m not sure if I’m reading it right, but it looks treacherous for equities.

  3. 3 hotairmail

    @Tim - try plotting from the start of 03 - you will see a ‘vacuum’ open up almost immediately.

    The convergence at the top that you have is a neat function of stockcharts fiddling around with the dimensions to come up with the ‘best fit’ picture.

  4. 4 Tim

    @hotairmail — thanks. I wasn’t sure how to read that chart. Well, it’s certain stocks are being vastly outperformed by bonds. Only question is how that divergence will correct — either stocks will rally huge and bonds will plummet or bonds will keep rising and stocks will plummet.

  5. 5 Tim

    this is the chart plotted from 2003…still not sure how it can be used for analysis though

  6. 6 burt

    Thanks for the nicely put together review. Without this blog, I would probably miss much of this stuff.

    Many columnists have noted the retail exodus from stocks. Why is this bearish? Isn’t the retail investor always wrong?

  7. 7 paul

    “It is very unusual for investors to ignore a rising market. But it is an understandable reaction after having been burned so many times within a decade. The last time we saw such “scarring” in the psyche of investors was in the aftermath of the 1970’s bear market. Then, as now, US retail investors left equity mutual funds in droves. In fact, from 1974 to 1982 US equity mutual funds saw net redemptions every single year. This is exactly why I made the distinction between the short term and long term consequences of the fund flows we are seeing. While in the short term we can interpret them as a counter indicator to the extremely bullish sentiment registered in the various surveys and polls, in the long term the stock market needs the patronage of US retail investors to be able to embark on and sustain a new secular bull market.” — Trader’s Narrative

    This movement can go on a long time. Given the demographic changes unfolding and the fact that stocks are still overvalued by some long term measures (see dshort’s 3 measures of market valuation) I expect to see it continue for many years to come. At least until equities compose less than 50% of the average investors portfolio.

    It strikes me as odd why any investor (not speaking to traders) would be interested in stocks until they trade at or below the level of these long term measures of valuation. Even if you don’t accept these measures as accurate we all know at times stocks not only trade at these valuations but even lower. Why not just wait until they get there again? You got 2 shots in the last decade — wonder how many will show up in the next 10 yrs.

  8. 8 thunderbird

    I suspect that Jim Rogers, looking at this through the lens of the 18-year commodity & equities cycles, would say that the equity market (and more importantly, sentiment about the equity market) has to continue to go down until, finally, you can’t find anyone who thinks that equities are an even remotely intelligent investment. That last happened in the 70s-80s, btw.

    I guess he’d say we’ll eventually see the S&P drop to below something crazy like 4x trailing earnings. Personally, I don’t see why you’d even hold a stock nowadays that doesn’t pay a dividend at least twice that of a t-bill: with all the extra risk of an equity, you’re counting on nothing but appreciation to make you your money, and that ol’ graph from 2000 to today shows that to be a bad strategy.

    Maybe Jim Rogers is wrong and the equity bear didn’t actually start in 2000? It doesn’t seem to, insofar as people today are still positive (or think you should be positive - see equity outflow discussion above) about buying equities despite their broader lack of performance. Maybe the bear did start in 2000, from an objective standpoint, but most people still haven’t clued in to it.

  9. 9 Babak

    DoctorRX, I don’t disagree with Rosenberg that the baby-boomers are shifting into bonds. They see few alternatives since both the stock market and the real estate market, long the favourite asset classes have burned their hands. At the same time, I don’t think the bond market is a safe haven here - unless we throw out the concept of regression to the mean. I’m loath to do that since that is exactly what provided the guidance re the real estate and stock market bubbles.

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