Sentiment Overview: A Remarkable String of Bullish Weeks

It is the end of the week and so we take a stroll through the sentiment meadows:

Investors Intelligence
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.

AAII
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.

Consumer Sentiment
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.

Option Traders
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:

Fund Flows
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.

Comments

[Shishir Nigam:]

You point out a very important contrast Babak. "And on average when the S&P 500 has rallied 60% from a recessionary low, this consumer sentiment reading is 90.5".

With the current sentiment index at 69.4, it goes to show how premature this extended rally has been.

For more analysis, check out my blog: youngandinvested.com

Oct 25 03:55 PM

[mgarrett:]

Thanks for pulling this data together. If the ISE index continues to foreshadow periods of equity weakness, It will be interesting to see how far below the buoyancy providing liquidity resides.

I believe some gyrations in FX markets of late also supports a weak equity thesis. Specifically, the final short squeeze in the high beta popular short that is GBP/USD. This may mark an intermediate term counter-trend move or even (if the Elliott wave guys are right) a trend reversal in USD. Conventional wisdom suggests month end currency hedge adjustments should put pressure on USD. I am not willing to bet on that.

Oct 25 07:55 PM

[Options Tra...:]

Don't really need any timing signals to know that 10,000 points is a strong psychological resistance level.

Oct 25 11:46 PM

[Joe Shareho...:]

It's a game the Fed has played brilliantly. Pass out TARP, short the hell out of the banks, coordinate the bank press announcements about strong earnings in early March, and then watch the profits roll in. However, think the Fed knows this rally was all a game?

Oct 26 12:37 AM

[mgarrett:]

The other major issue for this market to come to terms with is, one source of liquidity injections into the financial system is nearing an end. The Treasury POMO only has one bullet left in the magazine. Yes, there is still a mountain of MBS purchases in the arsenal, but I don't know if these have the same firepower as the treasury purchases. This is speculation but I believe a lot of the MBS' that are purchased may have be whats posted as collateral so net net your not getting as much of a bang for the buck.


On Oct 25 07:55 PM mgarrett wrote:

> Thanks for pulling this data together. If the ISE index continues
> to foreshadow periods of equity weakness, It will be interesting
> to see how far below the buoyancy providing liquidity resides. <br/>
>
> I believe some gyrations in FX markets of late also supports a weak
> equity thesis. Specifically, the final short squeeze in the high
> beta popular short that is GBP/USD. This may mark an intermediate
> term counter-trend move or even (if the Elliott wave guys are right)
> a trend reversal in USD. Conventional wisdom suggests month end
> currency hedge adjustments should put pressure on USD. I am not
> willing to bet on that.

Oct 26 03:37 PM

[Mad Hedge F...:]

mmnd When everything is working, and my portfolio is firing on all 12 cylinders, I pinch myself and ask “Is this real? What can go wrong?” I’m reminded of the slave whose task it was to remind conquering Roman generals “All glory is fleeting.” Virtually all of my recommended core longs in gold, silver, Canadian, New Zealand, and Australian dollars, Brazil, Russia, India, South Korea, Taiwan, Vietnam, and junk bonds are at or near highs for the year. I called the bottom in Natural Gas within 40 cents, and mercifully baled on my one short in US government bonds, the TBT. What we are seeing is a global surge in liquidity as cash emerges from the bomb shelter, squints at the day light, and then rushes to buy the first thing it can find. Everything is going up, regardless of fundamentals. It is the proverbial tide that is lifting all boats. You can make a lot of money in these conditions, but there is no way of knowing if this will last for one week, or another year. But they can go on much longer than you think. In the last two liquidity driven markets I traded, Japan in the eighties and NASDAQ in the nineties, fundamental analysts railed against the tide for years, claiming that stocks were overvalued, each call getting their office moved ever closer to the elevator and men’s bathroom. When someone finally did throw the switch on these markets, it got dark amazingly fast. Tokyo went out at an all time high on the last day of 1989, and then dropped a staggering 45% in January. NASDAQ plunged just as fast from its 2000 top. The one thing we can all be certain about is that the survivors have vastly improved their risk control after our recent crash. Make hay while the sun shines, but keep your finger hovering over that mouse. The level of risk is definitely high than it was in March. When the next real downturn starts, it could resemble a flash fire in a movie theater.

Oct 26 06:24 PM