Sentiment Overview: Week Of December 24th 2010

Happy holidays to you and yours! There is a lot to cover so fortify yourself with a cup of eggnog or hot apple cider before proceeding to the sentiment summary for this shortened holiday trading week:

Sentiment Surveys
Two weeks ago we thought we were seeing some truly extreme bullish sentiment with the AAII bull ratio reaching 70%. But the current numbers make that pales in comparison. This week, of the US retail investors polled by AAII 63.3% were bullish and only 20.3% bearish.

To find a larger bullish camp we need to go all the way back to November 18th 2004 – when 64.1% were bullish. Taking into account the relative bullish sentiment through the bull ratio, the current condition is beyond extreme. The current bull ratio jumps to 79.4% – meaning of those who are not neutral, almost 8 out of 10 are expecting higher prices.

To find a more lopsided bullish scenario we have to cast our gaze back back to July 13th 2005 when the ratio was 80.5%. As these previous historical record bullish numbers indicate, while the current AAII levels are truly extreme, we have seen this indicator reach even higher levels.

But it is very rare. Considering all the available AAII survey data, we have only seen the bull ratio higher only 2.6% of the time. In other words, if we were looking at 1000 weekly observations, only 26 weeks have provided us with even more enthusiastic expectations of higher prices.

As you’d expect, historically the S&P 500 has struggled going forward when confronted with such a degree of optimism. When the bull ratio is 80% or higher, the S&P 500 index fares the worst in the medium term with an average return of -2.7% for the following two months.

Investors Intelligence
Newsletter editors monitored by the Investors Intelligence sentiment survey are growing more bullish but have yet to reach previous extremes. This week 58.8% of newsletters were bullish on the stock market while bears added a sliver from last week to reach to 20.6%.

This means we are seeing 2.85 optimists for every 1 pessimist. That is just slightly below the 3:1 ratio last seen at the market top in April 2010 and January 2010. Put another way the bull ratio is 74%, the highest since early May 2010. But if we just look at the portion of bulls, then this is the highest level since October 17th, 2007 – when it was 62%.

NAAIM Survey of Active Managers
This week’s survey of active money managers shows them continuing to increase their portfolio’s long exposure to the equity market. The average exposure is 82% while the median is 92.5%. This is the highest level of optimism from this indicator since late March and early April 2010 just as the S&P 500 was peaking.

As well, while the current result is an average, the final number itself can at times hide how much disagreement or agreement there is as to the final result. Currently, the individual opinions are acutely concentrated together with extremely little dispersion. This tells us that not only is there conviction of even higher prices ahead but that there is little disagreement between the individual managers.

By itself, such clear group-think wouldn’t be dangerous but it is very much so – from a contrarian perspective – when it is coupled with such overall exuberance. There was only one period of time when there was even less disagreement between the NAAIM survey participants. This was in December 2006, accompanied by bullish sentiment just as now. The S&P 500 managed to continue climbing and topped out shortly thereafter in February 2010.

TSP Sentiment
This survey of US retail investor sentiment is back up to an extreme with 3 times as many bulls as bears. The current TSP numbers are: 64% bulls and 20% bears. This is the highest bull/bear ratio since December 2009. Because it is a very volatile indicator, by itself, it wouldn’t be significant but together with the other survey results we’ve looked at above, it served to confirm that there is quite a bit of enthusiasm for a continuing stock market rally.

Hedge Fund Sentiment
According to TrimTabs, almost 50% of hedge fund manageres surveyed last week are bullish on the S&P 500 index. Just 19% are bearish. As well, 65% will keep their current leverage, 23% will increase it and only 12% will reduce leverage.

Wall St. Strategists
The USA Today’s 15th annual investment roundtable offers a glimpse into the mood of the average Wall Street strategist. The 5 experts interviewed were Richard Bernstein, CEO and chief investment officer of Richard Bernstein Advisors; David Bianco, chief equity strategist of Bank of America Merrill Lynch; Bob Doll, chief equity strategist of BlackRock; Abby Joseph Cohen, senior investment strategist and president of Goldman Sachs’ Global Markets Institute; and Dan Chung, CEO and chief investment officer of Alger Funds’ Fred Alger Management.

Their advice to the average investor, put concisely, is to get out of bonds, shake off any reluctance they may have and invest in stocks. Their arguments are that the economy is improving, a large portion of the S&P 500 index earnings come from overseas where the economies are even stronger and finally, corporations have significantly improved their balance sheets and will be putting their cash to use, buying back their stocks even if retail investors don’t.

I’m not surprised to see Abby Joseph Cohen being the effervescent cheerleader as usual. I have yet to read anything remotely bearish from her – ever. But Bianco’s bullishness is surprising, especially because he is much more nuanced and agnostic about the market.

A Bloomberg survey of Wall Street investment strategists expectations for the next year show an average gain of 11% for the S&P 500 index or an average taget of 1370. The investment experts interviewed for the recent Barron’s cover are also bullish, expecting another positive year ahead. The average target for the S&P 500 index is 1373, a 9.3% gain from Thursday’s close. Here is a more detailed outlined of their views:

Meanwhile, according to a recent survey by ICI, young investors shunning stocks. Having seen the volatility to rival a wild roller-coaster ride, they are reluctant to allocate a significant portion of their retirement savings to stocks, preferring safer asset classes like bonds and CDs. According to the survey, investors 35 or younger were only allocating 22% of their retirement portfolios to stocks.

The type of emotional turmoil that the average young investor has witnessed; with the popping of the tech bubble in 2000 and then the housing bubble and the credit crisis, has lead them to become very skeptical of the stock market as a vehicle for generating real returns. As well, seeing the weakness in the US economy and being buffeted by high unemployment, they are understandably wary of risk and may very well take that view point with them into the rest of their life. This dovetails with the other data we have regarding the dichotomy between advisors and other financial ‘experts’ and their clients.

‘Honor Roll’ Newsletter Sentiment
According to Mark Hulbert, the select few newsletters that have outperformed in both down and up markets have positive expectations for the new year. There are only 6 newsletters on this exclusive list based on their performance in the past 15+ years. Last year they were bullish as a group and correct. And right now they are all slightly more bullish than last year. They each have a different rationale with most referencing the third year of the presidential cycle seasonality.

You can watch a video with Hulbert about this here. Sentiment Survey
While this isn’t a scientific poll, the recent online polling of readers of the investing and trading website,, is confirming the general bullish mood. The current survey has 55% bulls, 25% bears and the rest (20%) neutral.

Japanese Retail Sentiment
According to a survey conducted by Reuters, Japanese retail investors are becoming bullish again towards domestic stocks. The sentiment index which is a net of bullish sentiment minus bearish sentiment, jumped from -60 to -2. This is the highest since April 2010 when the net sentiment was positive – something it had not been for more than 3 years. The survey was conducted in the first week of December when the Nikkei had rallied 13% from November and reached a 7 month high.

Almost half of the respondents (48%) expect the Nikkei to continue rallying and rise between 11,000-12,000 by the end of March 2011. That is a further increase of 8-18% from its close as of the date of the survey.

According to the latest data, the trading activity from Japanese margin traders shows that they are approaching levels of profitability not seen since May 2010. This indicator hasn’t yet reached the historical extreme but it is close to doing so and usually when it does, it is a sign of too much speculative froth and consequently a market top.

Checking in with our greybeards, Steve Leuthold is pulling in his horns and reducing his long exposure. He continues to be bullish on foreign stocks, especially exotic places like Vietnam. You can view his recent interview with Liz Claman of Fox Business.

Another greybeard, Doug Kass is also much less bullish. He wrote recently:

I suspect that the punishment those investors experienced in 2008-2009 was too brief or perhaps it was reversed too soon. (Of course, there is always the chance that such behavior won’t be punished again the second time around!) Nevertheless, with stocks so elevated, I believe the prudent course shouldn’t be the adoption of too much risk at the current time.

Arguably, over the past few months, investors’ heads we win, tails we win response to news is becoming increasingly reminiscent of the period approaching prior market peaks, providing to me (again) a clear reminder of the wisdom of Santayana, who once observed that ‘those who cannot remember the past are condemned to repeat it.’

Finally, while not technically a ‘greybeard’ the folks at Vaiant Perception have a respectable track record and are also sounding the alarms for the equity market. They write to their clients:

We recommend hedging equity portfolios and reducing market exposure.

Almost all our sell indicators are going off and we recommend hedging portfolios or reducing exposure. The last time all our sell signals went off was in early January and late April. Both cases led to short-term stock market weakness.

Our longer-term cyclical view is intact. We continue to see the US and the world as being in a mid-cycle slowdown. Money growth is accelerating and the diffusion of OECD leading indicators is positive. We would be buyers of global equity markets on any sizeable correction.

We are now seeing almost all our sell signals go off and we recommend clients hedge portfolios and reduce market exposure. We have advised clients in the past to hedge their portfolios and reduce exposure when all our sell signals have gone off. The last two times all our sell signals were activated was in January and April. In both cases the stock market performed very poorly one month out.

Fund Flows
According to the ICI, the latest mutual fund flows for the week show the retail investors abandoning the bond market. We had already seen this in mid to late November but the previous week was the largest single weekly outflow in some time. US investors withdrew $8 billion from bond funds with the amount being almost equally divided between corporate and government bond funds ($3.8 billion) and the municipal bond market ($4.9 billion).

According to Lipper FMI, for the week ended Wednesday, municipal bond mutual funds lost $2.9 billion. This on top of the $2.7 billion they lost the previous week. In fact, this marks the sixth straight week of declines which have sucked out a total of $12 billion from the municipal bond market. This follows a 30 week positive inflow streak that preceded the November declines that precipitated this outflow. From a contrarian viewpoint, this outflow is indicative of a panic mindset and confirms my bullish outlook on the municipal bond market going into the new year.

As we’ve observed from the various sentiment surveys above, there has developed a general disaffection towards the stock market. And so this week the withdrawals from domestic equity funds continues with a $2.4 billion outflow. The running total for December so far is $6.8 billion, slightly below the $7 billion level for all of November.

Foreign equities meanwhile are continuing to receive some small semblance of devotion. They have attracted $5.8 billion of inflows this month (so far) and at this rate will overtake last month’s inflow of $5.9 billion.

Here is a recent video interview of Charles Biderman of TrimTabs talking about the flow of money in mutual funds and ETFs:
Vodpod videos no longer available.

Initial Public Offerings
In a recent weekly sentiment overview I touched on the effect of the Chinese invasion on the US IPO market. With the year closing, the IPO market has definitely woken up from its slumber. The gargantuan $16 billion General Motors (GM) IPO was clearly an outlier and skews the total results. If we remove both this, the single largest issue, as well as the Chinese IPOs, then US public offerings were slightly behind where we would expect them to be during the current economic cycle.

According to Renaissance Capital, there were 465 issues that went public raising a total of $232 billion. This compares to 555 issues in 2007 raising a total of $265 billion. Going forward, the pipelines are healthy and with improving sentiment and participation from retail investors, the rosy glow of health will continue to return to this important subset of the stock market.

Options Sentiment
Considering that we’ve been looking at the ISEE sentiment ratio and CBOE options markets in great detail, I thought instead we’d look at the S&P 100 index (OEX) options market this week.

But before that, here’s a quick recap of the ISE sentiment data: the 10 day moving average of the equity only call put ratio ended the week at 243, down from its recent high of 267 reached on December 14th 2010. The 10 day moving average of the CBOE equity only put call ratio rose slightly to 0.51 this week.

Here is a long term chart of the 5 day moving average of the OEX put call ratio:

There are a number of points that need to be highlighted. First, the OEX option traders are considered the ‘smart money’ and their positions are not interpreted via contrarian analysis. Currently, they have been favoring puts by a wide margin. For example, on Thursday they traded more than 3 times as many puts as calls. But this has been in flux lately. The volatility that we’ve seen during the past few weeks in this option ratio is rather remarkable and rare. The whipsaw from extremely bullish to bearish to back again and once again is dizzying.

The current one week’s worth of trading activity (5 day average) is at 2.24. The 10 day moving average is at 1.61 – historically when the 10 day moving average has been this high, the S&P 500 index has lost an average of 3.6% the following month and been negative 75% of the time.

The message from the options market is crystal clear. Any way we slice and dice the data, the same conclusion is reached: an overzealous penchant for call buying which comes implicitly with an overwhelming expectation of further stock market gains.

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7 Responses to Sentiment Overview: Week Of December 24th 2010

  1. George Muzea says:

    You are doing a fantastic job; best I have ever seen in displaying and analyzing investor and institutional sentiment……….

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  3. Stacey Carter says:

    I can only agree with George; your sentiment commentary really gives quality food for thought.
    Sentiment seems to be nearly all pointing in one direction — that the current market is in rarefied territory, and likely to fall. The one conundrum is the mutual fund flows — the fact that domestic equity funds continue to see out flows. I would have thought there would at least some capitulation at a top; inflows for a few weeks. So this is interesting. I wonder if anything can explain it … such as maybe the public have been entering the stock market via other avenues.

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  7. Babak says:

    Thanks George, I’m a fan of your work as well. I read your book (The Vital Few vs. Trivial Many) a few years back and re-read it or refer to it once in a while as reference. Few books last like that!

    Thank you Stacey. Yes, sentiment is quite clear right now. The only caveat is that during a strong bull market it usually takes a bit until the contrarian effects take hold and we see the market crack. So sometimes people can get lulled into a false sense of security as the market inches ahead. But what the market gives in little by little, it takes away in one big swoop! As any market watcher knows, prices can fall much faster than they rise.

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