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Sentiment Overview: Week Of September 18th, 2009 at Trader’s Narrative

Here is the round up of sentiment data for this week:

Sentiment Surveys
According to the weekly AAII sentiment survey, US retail investors are pretty much split evenly between the bullish and bearish camps. The bulls are at 42% ( that’s a 5% point increase from last week) while the bears are at 40% (4% point decrease from last week).

ChartCraft’s Investor Intelligence measure of stock newsletter editors has taken the bullish mantle from the retail investor’s survey for several weeks now. And it continues this week as well. The latest II poll shows the bulls commanding a 47.8% share of the respondents (down slightly from last week) and the bulls, 24.4%. The simple bear/bull ratio continues to run at about 2:1 - giving contrarians a clear signal.

German ZEW Survey of Investor Confidence
Turning our attention to the other side of the pond, the German ZEW sentiment survey of investor confidence (green line in chart below) came in slighly short of the 60 expectation but still managed to climb to 57.7 - its most bullish level since April 2006. However, the survey’s “current economic” outlook - while slightly off its recent lows - is still mired at historic depths (blue line):

ZEW sentiment Germany Sept 2009

This month’s survey results mark one of the few times in the history of this statistic where there is a large mismatch between the two measures. While the current economic situation is still deemed to be very poor, confidence in the future is very high. This should be familiar as it is the same tune that everyone is humming in the US markets. The question then is what happens if the rosy expectations of the future do not come about?

Option Traders
Both the CBOE put call ratio and the ISEE index are showing an excessive bullishness. This should be normal but since they have disagreed with one another so much, it made me sit up and take notice.

The CBOE put call ratio (equity only) dropped to a low of 0.45 earlier in the week (Wednesday - September 16th, 2009). That’s a lot of call buying! The short term moving average of the daily put call ratio continued to decline as it has for the past few months. It is already below its long term channel so it is difficult to determine what if any sort of signal it is giving now.

The ISEE index (equity only) meanwhile jumped to 242 on Wednesday’s long range candlestick. That means for every 100 puts, 242 calls were bought (to initiate a position). To find a more bullish one day statistic, we’d have to hop into our time machine and travel back to November 6th, 2007 when the ISEE index hit 245. At that time the S&P 500 was trading around the 1500 level. More important than just the one day spike, the 10 day moving average for the ISEE is now also significantly high as shown on the chart below:

ISE sentiment 10 day moving average Sept 2009

As of this Friday, the 10 day moving average for the ISEE call put ratio index is at 188. To find a more bullish time, we have to go back to November 14th, 2007 where it was at 191. I’ve been patiently watching this indicator as it meandered in milquetoast fashion for some time. Now we are seeing the first signs of a definitive bullish excess. The only other thing I would add is that it can become even more excessively bullish, as it has in the past, pushing as high as 245. So this could potentially just be the beginning but nevertheless, we now have a signal worthy of contrarian thinking.

Bloomberg Professional Global Confidence Index
The poor US dollar. It is the most unloved world currency. According to the Bloomberg Professioanl Global Confidence survey, dollar pessimism is at an 18 month high. Although the Bloomberg survey consists of ‘professionals’ in the field of finance, they are in agreement with the retail investors in shunning the US dollar (US Dollar: Contrarian Bullish). Of course, most of the decline in the dollar is due to the relative calm that has return to the world’s credit markets. With the worst of the financial crisis over (see TED spread below), there is less and less need to take cover in the safety of the world’s reserve currency.

For the world economy the BPGC index inched higher in September, climbing to 58.54 - that’s the second month above 50 which means that optimists yet again outnumber pessimists. But the largest jump was in the Latin American sub-index where Brazil, one of the biggest and most robust economies has emerged from its funk. Incredibly, the BOVESPA has doubled since its low in late October 2008.

The 1800+ survey participants were less enthusiastic about the US equity markets expecting a correction in the following 6 months.

TED Spread
Last year, everyone was glued to a few indicators which showed the health of the world economy like an EKG reading. The TED spread was one of the most important as it monitored the financial crisis in real time as each market opened around the world. Fast forward to now and it is the lowest since 2004. A few days ago it was at 16.8 basis points and has since bumped a bit higher into the 20’s:

TED spread graph 2002 to Sept 2009

The TED spread measures the difference that the US government pays (Treasury) to borrow money vs. private banks (Eurodollar rate). It is a direct measure of confidence within the global financial system so seeing it close to its historical low is reassuring. However, before we get too comfortable, we should also keep in mind that the last time it was this low the world looked a lot different than it does now: unemployment was not a concern, the economy was humming along, the housing market was healthy and the stock market was in a bull market.

Mutual Fund Flows
I’ve touched on this a few times (most recently in, Are Retail Investors Really Coming Back?) but it is so pivotal that it bears repeating. Even as the equity market has staged the most impressive rally ever out of a recession, it has completely failed to impress the average US mutual fund investor enough to have them channel their assets towards equities.

In fact, since March 2009 begat this rally, the vast majority of fund flows have being diverted to fixed income. And by vast majority I mean a 20:1 margin. Shown as a pie chart, it looks like Pac Man in mid chew. It makes you wonder just what it would take for the US retail investor to get excited again about equities. But it also clearly establishes that we are not even remotely close to exuberance on the part of the US retail investor.

equity bond fund flows Sept 2009

This lopsided allocation is in direct contrast to the last bull market. From the time that the last bullish cycle began in late 2002 until 2007, the US mutual fund investor plowed more money into equities than bond funds by a margin of 2.5 to 1. As contrarians, this is an important bearish signal for bonds as well as a significant bullish one for equities because whenever retail investors have rushed into an asset with breathless abandon while ignoring another, historically, it has paid to do the opposite.

Of course, both retail investors and Wall St. titans are susceptible to such emotional decision making and herd mentality. The only difference is that while the former takes losses from such mistake and trundles on to the poorhouse, the latter is made whole (through a transfer of wealth from the former via the government) and continues to strut on Easy Street.

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