Sentiment Overview: Bullishness Drops With the Market

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Includes: DIA, QQQ, SPY
by: Babak

Here is this week’s sentiment recap:

Sentiment Surveys
The weekly AAII survey this week pretty much sums up the sentiment picture we’re going to look at. Retail investors grew rather bold in mid-June, taking the bull ratio to 58%, as the market seemed to recover. But then this week, with the S&P 500 dropping below its recent lows there are very few optimists around.

AAII bull ratio Jul 2010

This week’s AAII shows only 24.7% bullish and 42% bearish. That drops the bull ratio down to 37%, where it was on May 27th 2010 when the S&P 500 was trying to stabilize. Basically, sentiment bounced back much more than the market gave it reason to and now it has fallen back down along with stock prices.

I can’t help but compare the recent correction to the one we saw in November 2009. That decline was just 6% on the S&P 500 but it produced an AAII bull ratio of 28% (meaning 28% of people with an opinion were bullish). The latest decline in contrast has taken the S&P 500 down by 16%. Yet we are still seeing rather elevated bullishness.

Investors Intelligence
Unlike the retail investors, newsletter editors monitored by ChartCraft were basically not impressed with the brief recovery so the bull/bear gap didn’t change much. This week we find them basically where we left them last week: 41.1% bullish and a tiny bit more pessimistic at 33.3%. That give us a bull/bear ratio of 1.23:1 not very different from last week’s 1.32:1 and not even that much far from early June 1.21:1.

Secret Survey
I’ve recently stumbled on a sentiment survey which is not very popular at all but which has all the makings of an amazing sentiment indicator. It is weekly, it targets retail investors, and it goes back several years. A cursory study of the available data shows it to be a contrarian indicator. Because I’m not finished researching it, I don’t want to reveal too much but I’m too excited to keep totally silent.

Right now, according to this survey there are 0.57 bulls for every 1 bear. That’s quite a bit of pessimism but it isn’t extreme. There was an extreme reading in late May which was remarkably lower than the reading from March 2009! I hope to have a better understanding of it in a few weeks at which time I’ll write more about it.

NAAIM Survey of Manager Sentiment
Active asset managers surveyed by NAAIM suddenly changed their minds and significantly reduced their exposure to the stock market this week. The most recent low for this indicator was 27.05% in early June just as the market seemed to finally have found firmer footing. As a result, the NAAIM sentiment sharply increased to 54.24% last week.

NAAIM survey of manager sentiment Jul 2010

As I noted in last week’s sentiment overview, this was surprising and bearish since the market had actually fallen slightly. On June 2nd, the S&P 500 stood at 1102.83 and on June 30th, it closed at 1092.04. But the (mean) NAAIM sentiment had increased during that time from 27% to 54%.

So what we are seeing this week isn’t all that surprising when taken in that light. Stepping back further, the NAAIM sentiment is still rather elevated at 36% - being higher than where it was on June 2nd - even though the market is now 75 points lower. This means that there is a bit of insistence on the part of asset managers as the “look on the bright side of life”. If you’re looking for a lasting low, as a contrarian you would much rather see them throw in the towel with disgust. Since that is not what they are doing now, previous patterns would suggest that we need lower prices to induce such a capitulation.

Consumer Confidence
The Consumer Confidence index (from the Conference Board) fell to 52.9 from the revised level of 62.7 in May. The consensus expectation was a slight decline (62.5) but the actual number produced the largest decline since February 2010 and took the index down to a 3 month low.

Historically, during recessions the Consumer Confidence index averages 70 and during economic expansions, 100. So according to the continued low readings in this index, the US economy is still mired in a deep recession. Other parts of the survey are equally pessimistic. Only 10% of respondents responded that they believed business conditions were good.

Mutual Fund Flows
US retail investors continue to withdraw money from their equity funds. According to the latest ICI data, domestic equity funds have seen an outflow of $7.9 billion for the month of June. This on top of the $23.6 billion that was taken out in May 2010.

Bond funds continue to be the favorite garnering the majority of the money being socked away. But even this investment destination has seen a drastic reduction. Last month bond funds received $19 billion and in May they received inflows of $16.9 billion. This is much lower than the multiple months from July 2009 to March 2010 where bond funds had inflows of $26 to $47 billion.

Rydex Traders Sentiment
The market has done the same “head fake” to Rydex market timers. The assets of the S&P 500 index inverse fund (previously known as URSA) surged as the market declined and then receded with the short lived recovery. They have now increased once again and are very close to hitting the levels of last summer:

Rydex URSA inverse fund assets compared to SPX Jul 2010
Source: McClellan Financial

While the nominal asset levels are contrarian bullish, what concerns me is how ready the Rydex traders were to believe in it.

Corporate Buybacks
According to Standard & Poor’s US corporations increased their stock buybacks by almost 79.5% in the first quarter of 2010 to $55.3 billion, compared to last year’s first quarter. This is the 3rd consecutive quarter that S&P 500 index constituents have increased their buyback activity.

It seems that at least some of the cash hoard on companies balance sheets is being directed to share buybacks. Among the sectors, the technology sector which has been leading the charge in performance on the index accounts for the largest share of buybacks (29.3%). Consumer staples is second with 19.3% of the share of buybacks. In contrast, utilities and the telecom sector actually decreased their first quarter buyback programs.

Option Sentiment
The lack of concern from the options market should be noted by the bulls. While the S&P 500 index has clearly fallen below the late May lows, the CBOE put call ratio (equity only) is not showing any real sign of concern. In fact, the 10 day moving average which tracks the past 2 weeks of trading for puts and calls is now lower than it was in late May.

On Tuesday, when the S&P 500 decisively broke below the lows in May, the CBOE equity only put call ratio was shockingly subdued at 0.79. On a day when major support is broken and the index closes down more than 3% you would imagine that we at least see the ratio hit 0.90 or even 1.0!

The same complacency can be seen on the ISE with the ISE sentiment index falling to 126 on Tuesday (implying that option traders were buying 126 calls for every 100 puts). That is not indicative of any real “fear” or even concern. Even more surprising, on Thursday when the market was weak - but closed higher than the intraday lows - the ISE equity only call put ratio was 200!

Gold Sentiment
As soon as I reduce my skepticism regarding gold’s relentless bull market it drops more than $40/oz. or 3.52%. The DSI for gold is still elevated at 90% but the Hulbert Gold Newsletter Sentiment index which tracks the small group of stock newsletter editors that try to time the precious metal shows a different story.

According to the HGNSI not only is there a total lack of excitement about gold’s performance, especially since it is so close to its high, but the recent drop has caused even more advisors to jettison it from their holdings.

In late June when it was creeping higher close to taking out the $1250 level, the HGNSI was at 37.8%. Now, after Thursday’s drop, it is 23.5%. And at the top in early may it was only 46.6%! I’m not sure what it will take to get the gold bugs excited about the yellow metal again. Over the years, a HGNSI reading of ~70% has corresponded with tops. Since we are very far away from that now and since there is no stubbornness shown on the part of gold bugs, this would suggest that gold can recover and continue on its way.

Similar to the HGNSI, Rydex gold market timers have also throw in the towel. As the fund itself has lost 10%, from June 25th, so has the asset base shrank 10%. Also consider the fact that the assets for the Rydex precious metal fund are still very low compared to the last time that gold was trading this high (December 2009). This tells me that we aren’t seeing a rush of speculative after gold and that the trend could continue.