Sentiment Overview: Returning to a Bearish Outlook

Includes: DIA, QQQ, SPY
by: Babak

Here is a stroll through the sentiment data for the past week:

Sentiment Surveys
Let’s start by looking at the various surveys which measure market sentiment.

The weekly AAII returned to a more bearish stance. Those expecting lower stock prices rose to 42.5% while those expecting higher prices fell to 30%. We are more or less still within a neutral sentiment range, as we have been for the past month:

aaii bull ratio Aug 2010

This week’s move away from the almost outright bullish sentiment of last week is noteworthy. But I’m waiting for the bull ratio (See above chart) to do something other than “meander with a mazy motion”. It will have my undivided attention when it either falls lower to 30% or less, or it rises above 60%. Until then.

ChartCraft’s Investors Intelligence survey showed a similar shift to less enthusiasm this week. The bulls fell from 41.7% to 36.7% while the bears increased slightly to 31.1% from 27.5% last week. The bull bear ratio fell to 1.18; telling us that there was almost parity again between the two camps. This is a significant shift from just last week when there were 1.52 bulls for each 1 bear.

Merrill Lynch Survey of Fund Managers
The recent Bank of America Merrill Lynch survey of institutional money managers reveals that the majority (78%) believe that a ‘Double Dip’ recession is unlikely. A net 5% of respondents expect the global economy to improve in the coming 12 months. This is a major shift from last month when net 12% expected the state of the global economy to worsen.

The survey shows a shift from US and Japanese equities towards beaten down European ones. A net 11% of survey respondents are overweight European equities compared to 10% underweight last month. Asset allocators moved to underweight US equities: a net 14% are underweight US equities while last month a net 7% were overweight. The shift in Japanese equities has been even more pronounced. A net 27% were underweight Japanese equities in August compared to 7% in June.

Concerns about China’s economy are receding with just 19% expecting it to weaken in the next 12 months. This is sharply down from 39% last month. As a result, global asset allocators are continuing to shift money towards global emerging markets (38% overweight).

Survey respondents have moved from concerns about deflation to a neutral stance on inflation. Not surprisingly, 55% believe there probably won’t be any interest-rate hike in the United States before the 3rd quarter of 2011. A large majority (73%) believe the US will have below trend growth and inflation. Only 1% forecast higher inflation in the next 12 months.

Fund Flow Data
The familiar trend in fund flows continues. According to ICI, bond funds have garnered almost $15 billion for the first two weeks of August. If that trend continues then by the end of the month the results will be in line with the average for the past 12 months. While chatter of a ‘bond bubble’ is building into a crescendo, the retail investors in the US are oblivious to the risk. If they are right, it will be the first time that retail investors have, en masse, correctly timed the market in a herd.

ici fund flows bond US equity Aug 2010

US investors are particularly becoming enamoured with municipal bonds. According to Lipper FMI, the week of August 11 saw a record inflow of $953.9 million into municipal bond mutual funds. In recent history, this was second only to March 2010 and compared to all weekly data going back more than 18 years it ranked 33rd. For more, see The Bond Buyer.

Equity mutual funds, the other side of the equation, continue to be shunned by US retail investors. According to ICI, we’ve had back to back outflows from US equity mutual funds for 15 consecutive weeks totaling almost $50 billion. Of course, the month isn’t over so if that trend continues for the next two weeks, the hemorrhage will worsen.

The above data looks at only mutual fund assets. According to Lipper FMI, if we consider ETF assets as well as mutual fund assets, US retail investors have withdrawn - just this week - $9.1 billion. While this isn’t a record weekly outflow, it is up there. In recent years, the worst weekly outflow from US equities came in mid-May 2010, followed by late June 2010. US retail investors’ distaste for equities is clear.

There are two main points to remember. From a contrarian point of view, when this reaches an extreme, it can mark an inflection point. However, if it merely continues in drips and drabs, as it has for the past 3 years, then an important source of demand is removed from the market and replaced with supply.

Corporate Insiders
According to data compiled by Thomson and, corporate insiders are buying more than they did a few months ago but the ratio of buying to selling is still mired in neutral:
insider transaction ratio Aug 2010

Insiders are usually considered ’smart money’ since they have an intimate knowledge of their business and are privy to non-public information flow. Right now they are picking up the pace of their buying a bit but they are not backing up the truck as they did in late 2008.

Option Sentiment
Option traders have not, for the most part, taken a decisive posture. Both the ISE sentiment and the CBOE put call ratio are middle-of-the-road neutral. The 10 day moving average of the (equity only) CBOE put call ratio finished the week at 0.676 - while in the big picture scheme of things this isn’t at an extreme, during the past few months, this level has served as ‘extreme enough’ to provide short term support for prices to find a floor:

cboe equity only put call 10 day moving average Aug 2010

The ISE (Equity only) call put ratio spiked to 256 on Wednesday as the S&P 500 tried to rally. With more than 2.5 calls for each 1 put, there was too much optimism for the rally to have any persistence. The 10 day moving average of the call put ratio is at 177 which is neutral:

ISE sentiment 10 day moving average Aug 2010