Let’s get on with this week’s summary of sentiment data because we have a lot to cover:
This week’s retail investor survey from the AAII shows an abrupt reversal. It was just four weeks ago in late August that the AAII’s bull ratio (the percentage of bulls divided by the percentage of bulls and bear) fell below 30%. That threshold is the limit I was watching as a sign of too much pessimism.
And now, we are seeing the exact opposite with 51% bulls and only 24% bears, giving up a bull ratio of 68% - the highest for the whole year and the level at which we’ve seen the equity market react several times previously. As you can see from the chart, in recent years, we’ve seen this level reached only a handful of times: December 2009, May 2008, and October 2007. A quick glance at the chart of the S&P 500 will tell you that all of those instances were much better selling opportunities than buying ones:
Having said that, looking at the long-term chart of the AAII data, it is clear that the bull ratio can reach much higher than the current 68%. In fact, as early as 5 years ago, the bull ratio went above 80%. And the highest point for the dataset was during the summer of 2003, at 89%. During bull markets, sentiment reacts differently and it takes quite a bit of optimism to reach an ‘extreme’ point.
In contrast to the AAII, stock newsletter editors, as measured by ChartCraft’s Investors Intelligence survey, were little changed from last week with 36.7% bulls and 31.1% bears. This is the second week the bulls have recovered from a yearly low but since reaching a top in January and April, optimism has been waning pretty consistently in this survey:
Daily Sentiment Index
This week the DSI for the S&P 500 index reached 83%. This is an elevated level but shy of an extremely optimistic level. In mid-April, the DSI reached 92% as the equity market reached an important top. For a chart with comparison to the S&P 500 index, see the previous Sentiment Overview (Week of April 16th 2010).
Bloomberg Professional Confidence Index
I was looking forward to this month’s results from the Bloomberg Professional Confidence survey but sadly, it seems that it is being discontinued. This survey was conducted through the Bloomberg terminal and reached mostly an institutional audience for their take on various financial and economic questions. The survey included geographic breakdowns as well as asset allocation questions. The chart below shows the historical results for the global economic sentiment.
Numbers below 50 indicates negative sentiment, while one above indicates positive sentiment.
Merrill Lynch Survey of Fund Managers
The latest Bank of America ML Survey of institutional managers shows an about face regarding China’s economic prospects. Now a net 11% believe that the Chinese economy will in fact strengthen in the next 12 months. And they have put money where their mouths are with a net 22% being overweight Chinese equities - a major shift from last month when 22% were underweight the Chinese market.
Institutional investors polled by the survey also acknowledge the growing valuation gap between equities and bonds. A net 68% believe bonds are overvalued while a net 38% think equities are undervalued. This spread is the largest since the survey was started in 2003. But even so, the risk appetite is limited with more moving to cash (those overweight cash doubled from last month). Generally speaking, sentiment towards markets in the US, UK and Europe is neutral.
NAAIM Survey of Managers
For the second week, active portfolio managers reduced their average long exposure in divergence with the stock market’s performance. This week the average long exposure was down slightly to 42% while the median exposure remained the same again at 50%. The diversity of answers to the poll continues to increase, suggesting that there isn’t a wide consensus among the managers.
This could suggest that managers are learning to trade within a range. Now that the indexes are heading into previous resistance levels, they are reluctant to add positions and are instead lightening up in anticipation of a continuing range-bound market.
The latest National Federation of Independent Business survey shows small business optimism continuing to wallow near historic lows. Most of that is attributed to pricing pressures and weak sales. The index has been below its previous trough (93) since January 2008 - the market of a severe recession with no end in sight.
The single most important problem for small businesses remains sales - or lack thereof. This has grown to be the major concern, overtaking both taxes and government regulation - both of which have remained relatively stable over the long term.
The recent Thomson Reuters/University of Michigan Consumer Sentiment survey fell from 68.9 to 66.6 (preliminary). This is the lowest number since April 2009 and a sharp drop from a few months ago in June (76). Most of the decrease is attributed to households with above average incomes ($75,000+) and their concern about the expiration of the tax cuts instituted by President George W. Bush. In contrast, lower to middle-income households optimism grew and their spending plans increased as President Obama is pushing for tax cuts to the middle-class tax bracket.
The measure of expectations (6 months forward) fell to the lowest since March 2009 - this gauge has historically approximated actual consumer spending. Most of the decline is due to the atmosphere of confusion over what, if any, tax changes are coming from Washington. The uncertainty of higher taxes is making many cautious and more willing to save, rather than spend.
The latest data for transactions by corporate insiders shows that they have now swung to an above average amount of selling. According to Vickers Weekly Insider Report (with data from Argus Research) insiders are selling 2.68 shares for every 1 they buy. This in contrast to the parity we saw at the end of last month (see, Sentiment Overview for the week of September 3rd 2010). Since the average pattern for insiders is to sell between double to 2.5 times the number of shares they buy, the current reading (for the week of September 6th to September 10th) is only midly bearish.
TrimTabs is cautiously bullish with a 50% exposure to equities because the trading float of shares is shrinking due to takeovers and company buyback programs. This means less shares outstanding (supply) and the same amount of money chasing fewer shares. As well, they are seeing consistent selling of leveraged long ETFs and consistent buying of leveraged short ETFs. Historically, this has been a good contrary indicator. Until the end of August, long leveraged ETFs were being bought and short leveraged ETFs, sold. But in early September that changed.
Meanwhile, in mutual fund land, US investors continued to pour money into bond funds this week with inflows of $5.7 billion. And they withdrew $2.2 billion from US domestic equity funds. Both weekly numbers are in line with the trend of money flows. For a chart of the dichotomy between bond funds and stock funds, see this previous Sentiment Overview.
The feeding frenzy in the high-yield bond market continues unabated and has managed to hit a remarkable milestone. For the first time since before the credit crisis, investors are acting as if they will be paid 100 cents on the dollar. According to Bank of America Merrill Lynch index data, the average junk bond rose in price above parity - the best showing since June 2007.
While volatility, as measured by the CBOE VIX index wallows in the low 20’s, another measure of option market fear, is showing the opposite. The CSFB Fear Index is built differently than the VIX. It measures fear through quantifying “zero-premium collars” out three months instead of the 30 day implied volatility. Put more plainly, it looks at the option skew between upside target and downside protection.
So while implied volatility languishes, traders are ponying up to pay more for downside protection than upside gains. Right now, after selling a call option 10% out of the money, you’d have to go 24% out of the money to go long an equivalent put option. The last time the option skew was this high was in late August - just before a shallow decline.
Looking directly at option sentiment through the ISE Sentiment index, we see that optimism continues to grow with the 10 day average equity only call/put ratio rising to 192 on Thursday before declining to 188 today. This is the highest since May, just as the market was rolling over from the April highs. At the top, on April 15th, the 10 day average peaked at an astounding 249 - implying that for the past two trading weeks, traders had been buying almost 250 calls for every 100 puts.
The 10 day moving average of the CBOE’s (equity only) put call ratio fell slightly to 0.59. Overall, the put call ratio is suggesting an optimistic sentiment but not as exuberant as what we saw in April 2010.