Retail investors responded to the strength of the stock market this week by increasing their bullishness. The AAII retail investor survey showed 49% of respondents being optimistic about future gains and only 23.2% bracing for lower prices. This results in a bull ratio of 64% and is the third week out of the past four weeks that the bull ratio has been 64% or higher:
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Normally a slightly higher bullish sentiment (68%) corresponds to market tops but such a persistent condition of bullishness should be troubling.
Stock newsletter editors also continued to increase their bullishness according to ChartCraft’s weekly survey of sentiment. This week the Investors Intelligence survey had the highest level of bulls (45.6%) since mid-May 2010 (47.2%). The bears increased slightly to 28.3% resulting in a bull ratio of 62%. This is elevated but significantly below the levels we saw in May 2010 (75%) when there were 56% bulls and just 18.7% bears.
NAAIM Survey of Sentiment
Active money managers surveyed by the NAAIM weekly poll show a similar increase in optimism. This week is the third consecutive increase in bullishness. This week’s mean NAAIM sentiment is 76.42% and the median 77.5%. Such an increase in long exposure isn’t that surprising when it is put in the context of a generally rising stock market. Managers rarely fight the trend but what we are interested in is extremes of sentiment and so far we aren’t seeing that. Below is a chart of the median NAAIM sentiment:
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We don’t have a very large data set for this sentiment indicator but from the available historical data, it is relatively rare to see a reading above +75%. This has only happened 16.6% of the time (or 32 times out of the total 223). The other notable fact is that we are seeing less disagreement within the survey results as more managers accept the ensuing rally.
One of the biggest questions swirling in financial circles is over the massive corporate cash pile. While the debate is still raging over whether it is a positive or negative, it seems that the corporations have found a use for all that cash that has been burning a hole in their balance sheets.
Since we last broached the topic, total non-financial cash holdings have ballooned to $1.8 trillion. And year to date, $273 billion worth of buybacks has been announced by US public companies. With the bond market providing a seemingly infinite demand from retail and institutional investors, corporations are finding it irresistible to not issue new debt at rock bottom prices and either lock in cash for the future or to turn around and use the cash to buy back shares on the open market. The source and rationale of the stock market’s buoyancy has been a controversial topic, especially in light of the retail investor exodus. I don’t pretend that this source of demand for shares is enough to fully explain that question but it is a fact that can’t be ignored, especially as buybacks continue to ramp up every quarter.
Mutual Fund Flows
In spite of positive market performance, the existing trend of US retail investors exiting domestic equity mutual funds and flocking to fixed income funds continued with the final weekly data for September’s fund flows. US retail investors sold slightly more than $20 billion of equity funds and plowed $32.5 billion into both taxable and non-taxable (municipal) bond funds. Since 2007 US investors have shifted $283 billion out of US equity funds and moved heavily ($762 billion) into bonds. And the trend shows no signs of changing or even slowing down.
Within the bond market, high-yield debt has received positive inflows for the 5th straight week. Fixed income funds specializing in junk bonds received $366 million net inflows last week, according to Lipper FMI. The previous week the inflow was $566 million and since July this sector has received $7.9 billion in net inflows as investors reach for yield. The average high-yield bond price is now above 100 cents on the dollar. According to data from Dealogic, public companies are taking advantage of the seemingly insatiable demand with $190 billion worth of junk bonds having been sold so far in 2010, easily trumping the 12 month total for last year, $164 billion.
The market can ignore the corrosive effects of this asset shift in the short-term. But eventually, unless it reverts back to its historical normal state of positive inflows into equities, it will have negative repercussions. These won’t be limited to just a reduced long-term return from stocks. By rushing into bonds as they are, investors are ignorantly exposing themselves to duration and default risk. And they are shutting down the IPO market which is a vital mechanism within the financial ecosystem.
For the past few weeks the option sentiment picture has been rather hazy. While there has been a lukewarm bullish tendency, we haven’t seen the kind of intensity that we look for as a contrarian indicator. Until this week. According to the option trading data from the ISE, four of the five trading days this week showed more than twice as much call buying as put buying to initiate a position.
That brought the 10 day moving average of the equity only call put ratio to 203 which is the highest it has been since April 30th. Granted, the ISE Sentiment index did reach into the stratosphere in April (the short term moving average peaked at 249 in mid-April). But reaching such thin air territory is extremely rare. Previous to that, we saw a similar call put ratio on January 19th, exactly before the S&P 500 index and the rest of the equity markets took a tumble. And prior to that, there was another example almost exactly a year ago in mid to late October 2009 - once again, a short-term top for the S&P 500 index.
The more traditional CBOE put call ratio is not providing a similar signal as it continues to be mired in neutral. The short term moving average for the CBOE put call ratio (equity only) is 0.593 - converted to the equivalent of call put ratio, it is 169. High, but not extreme enough to warrant a contrarian interpretation.