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Sentiment Overview: Week Of September 3rd, 2010 at Trader’s Narrative

Here is this week’s overview of various sentiment data for the financial markets:

Sentiment Surveys:
Last week the AAII’s weekly sentiment survey finally dipped into a bearish level as the bull ratio fell below 30%. This week the AAII poll of US retail investor sentiment showed a quick recovery from those doldrums: 31% bullish and 42% bearish.
aaii bull ratio Sep 2010
Since 2007, the average bull ratio is 47% so at 42% we are very close to a ‘normal’ sentiment reading with this week’s results.

Investors Intelligence
Whereas the retail investors became concerned about a prolonged stock market decline last week, newsletter editors suddenly were gripped with the same fears this week. The bulls fell to 29.4% while the bearish camp swelled to 37.7%.

This week was the first time since March 2009 that the number of optimists from the II fell below 30%. There is no question that the current Investors Intelligence reading is at an extreme which can be interpreted from a contrarian viewpoint to have bullish consequences for the stock market.

In the past 20 years, we’ve only seen the II bulls dip below 30% a handful of times. And each of those has been great buying opportunities in the medium to long term. But keep in mind that this does not forestall some potentially wicked retracements along the way.

NAAIM Survey of Manager Sentiment
The NAAIM sentiment survey which tracks active money managers was little changed this week. The median exposure to equities remained at 50% long for the 3rd consecutive week. Meanwhile the average long exposure increased slightly from 44% last week to 53% this week. So overall, it seems that active managers polled by this survey are reluctant to drastically change their stance and instead are taking a wait and see approach.

Analyst Sentiment
According to Bloomberg data covering 159,919 recommendations, for the first time since 1997 analyst “Buy” recommendations have fallen below 29%. The strange thing is that while analysts are turning more pessimistic, they are upping their S&P 500 earnings estimates.

In analyst speak, a “Sell” is extremely rare and a “Hold” is a synonym for sell. So it is shocking to see the combined “Sell” and “Hold” percentage for US stocks rise to 71% (as of last month). The pessimism pervades international markets as more than 54 percent of ratings for companies in the US, UK, Japan and Brazil are “Hold’s” - that is the highest level since Bloomberg began measuring the data in 1997.

This would be contrarian bullish for stocks, of course. An alternative explanation is that with correlation among stocks and the S&P 500 index extremely high, analysts are reluctant to put their reputation on the line. With the index determining the vast majority of the performance of individual stocks, there is little incentive for analysts to forecast which will beat the index.

Hedge Fund Sentiment
According to a TrimTabs/BarclayHedge survey of hedge fund managers, only 17% were bullish on the S&P 500 index in August. And an increasing number, 47%, had an outright bearish outlook for equities:

TrimTabs BarclayHedge Survey of Hedge Fund Managers Aug 2010

Instead, hedge fund managers were bullish on bonds with 36% surveyed saying they were expecting higher bond prices (only 17% were bearish). To me this is very surprising because basically we have the “smart money” agreeing with the “dumb money” and both crowding into the bond market.

Mutual Fund Flows & Cash
According to data from ICI, US mutual funds are holding in aggregate 3.4% of their portfolios in cash. This is slightly lower than three years ago just before the 2007 market top. The knee-jerk reaction is to interpret this as very bearish for the stock market. While this is obvious, you have to remember the monetary policy environment that investors are dealing with today.

equity mutual fund cash holdings Sep 2010
Source: Decision Point blog

Bernanke & Co. are doing their best to reliquify the US banking system by funneling massive amounts of zero-risk money towards them. All banks have to do is to hold reserves and get paid the spread. They don’t even have to actually do what their primary purpose is, lending. Instead, risk taking is being pushed onto the shoulder of investors since they have no real way to gain rents other than investing in equities. So far they have resisted being herded into equities as they had been so many times before and instead have headed en masse towards bonds (see the previous mutual fund flow chart of bonds and equities here and the more recent one below).

ici fund flows bond US equity Sep 2010

But mutual fund managers don’t have that luxury since they must follow buy and hold stocks. Right now, cash is more like an anchor around their necks since it doesn’t provide any return. So taking that into account, I’m not really surprised to see such low cash holdings in equity mutual funds.

According to ICI, US investors withdrew money from domestic equity funds for the 17th consecutive week. For the full month of August, there was an outflow of $11 billion out of stock mutual funds and an inflow of $28.6 billion into bond funds (both taxable and municipal). Since January 2007, US investors have withdrawn a total of $248 billion out of stocks and piled into bonds to the tune of $729 billion.

Within the bond sector, municipal bond funds are continuing to receive investors favor according to FMI Lipper. They received inflows of $728.4 million for the week of August 25th. This is slightly lower than the previous trend of about $900 million a week that we had seen most recently.

Junk Bonds
We already took a look at the white hot high-yield bond market a few weeks back. With August behind us, it is safe to label it a record setting month for junk bond issuance. According to Dealogic there was $23 billion snapped up - the 7th best month on record.

As large companies repair their balance sheets and forestall looming maturities, they are tapping the bond market with longer-dated issues. On the demand side, retail and institutional investors are hungry for anything that provides a better yield than Treasuries. Since we can look forward to both trends continuing, no one will be surprised to see new records set in the final months of the year.

On the other hand, since junk bonds usually move in tandem with equities, you have to wonder about the cognitive dissonance involved in the present situation. That is, shunning equities but rushing into high-yields!

Corporate Insiders
According to Vickers Weekly Insider Report (which relies on data from Argus Research) corporate insiders are now more bullish than they have been since April 2009. Their bull/sell ratio usually hovers around 2:1 and 2.5:1 - meaning that they sell a bit more than twice the number of shares they buy. The current reading (from last week) however is just 1.02:1. While it may seem that buying and selling an equal amount is extremely bullish (from a contrarian perspective) it is important to remember that insiders are allocated shares from share ownership plans or stock option plans. So their natural stance is long and it is normal for them to sell some or all of their shares to diversify their asset base.

Option Sentiment
Finally, looking at the options market provides little edge as traders are more or less neutral. The 10 day (equity only) ISE Sentiment index, which is a call put ratio, ended the week at 174, down slightly from last week. The most optimistic day during the week was Thursday as 221 calls were bought relative to 100 puts. The lowest reading in recent months was in mid-June (137):
ISE sentiment 10 day moving average Sep 2010

The 10 day moving average of OEX option traders put/call ratio ended at 0.982 - this is higher than the 0.80 level that we watch as being bullish but it is still lower than extremes which mark tops. So all in all, OEX option traders sentiment is neutral.

The traditional CBOE put call ratio (equity only) finished the week at 0.59 - this takes it back to the final days of July 2010, where we found it last at these levels. As you can see from the chart comparing the 10 day moving average of the put call ratio with the S&P 500 index, stocks had difficulty in climbing much higher:

cboe equity only put call 10 day moving average Sep 2010

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3 Responses to “Sentiment Overview: Week Of September 3rd, 2010”  

  1. 1 PEJ

    great post Babak, thank you!
    One thing that I don’t quite get, and is really symptomatic and exhibited by the equity analysts become bearish and upping earning forecasts, is that I do not see bearishness but mostly bullishness in most “pundits” and market “forecasters”.

  2. 2 RACKEL

    “…basically we have the “smart money” agreeing with the “dumb money” and both crowding into the bond market”

    Sounds like a bubble forming in the bond market. Once the dumb money is in a market who is left to keep pushing prices higher?

  3. 3 Daniel

    So thorough. So helpful. Much thanks.

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