Sentiment Overview: Week Of January 7th 2011

Sentiment Surveys
This week’s survey from the AAII (American Association of Individual Investors) had 56% bulls and only 18% bears. Overwhelming optimism has been so persistent that the 4 week average of the AAII bull ratio is now at 73%.

To find a time when it was higher, we’d have to go back to December 2004 when it peaked at 73.5%. The comparison to today’s market is inevitable. Just as now, the S&P 500 had been riding a momentum rally higher than anyone had guessed. Just as now, the stock prices pushed ahead in spite of very high bullish sentiment. And just as now, the stock market was entering a new year after a very good year – putting a harrowing bear market in its rear view mirror.

So how did things turn out? The S&P 500 managed to inch forward a bit more into January 2004 but then it hit the proverbial wall. For the rest of the year until November 2005, the S&P 500 struggled just to stay afloat. Peak to trough it fell 7.6% in April 2005. If a flat market is what we get after so much optimism, the bulls should throw a ticker tape parade in thanks to the trading gods.

Investors Intelligence
The survey of newsletter editors also continues to hover at very high bullish levels. This week the Investors Intelligence survey conducted by ChartCraft had 54.5% bulls and 20.5% bears. So we have about 2.7 bulls for every bear and a bull ratio of 73%. That is high but leaning back from the recent extremes in December 2010.

Daily Sentiment Index
The Daily Sentiment Index for the S&P 500 index is once again at 94% bullish. The EWI Financial Forecast has an interesting chart that incorporates this. It is the chart of the NYSE Composite index along with EWI’s own Breadth/Sentiment Composite indicator and the AAII and Investors Intelligence sentiment surveys.

Source: RMG Wealth

EWI’s Financial Forecast points out that the current bullish sentiment is unmistakeably similar to a previous market top. The conditions are uncannily similar:

• AAII reading was around 52% bulls – now the AAII reading hit 63.28% bulls
• Daily Sentiment Index reading neared 94% – now the DSI is the same, 94% bullish
• Mutual fund managers’ cash holdings were 3.5% -now it’s a record low of 3.4%
• headlines proclaimed higher stock prices – now we are seeing a similar pattern with headlines like “Year of the Stock” or “Experts Predict Strong Year For Global Stock Markets”

There are more comparisons but the chart is alarming. Take a look at the January EWI Financial Forecast with a 30 day free trial and if you like what you see, stick around.

NAAIM Survey of Active Managers
There was very little change in this indicator. The average notched down to 79% from 80% last week while the median was up to 90% from 85%. This is the fourth week that we’ve seen the median above 85%.

As well the bullish numbers are arriving with a consistent and narrow consensus from the respondents. Almost all the professional managers who took part in this survey believe that higher prices are around the corner and for the past few weeks they have been right.

State Street’s Investor Confidence Index
As custodian to institutional firms State Street measures the risk appetites of sophisticated investors. The most recent data for this monthly measure is for December 2010 and it shows an uptick in risk seeking:

But we have not yet recovered the levels from earlier in the decade. The level for December was 104.4 which is the highest since March 2010 (107.4). Looking back on the historical data for this indicator there seems to have been a change in the algorithm. I’ve contacted State Street and when I hear back from them I’ll update accordingly.

Reuters Asset Allocation Poll
The global survey of institutional money managers from Thomson Reuters. The survey results for December 2010 show an increase in equity allocation and a decrease in cash holdings:

The current 54.1% equity allocation is the highest in 10 months. Meanwhile cash in portfolios has shrunk to less than 4%. I chose to show the two together because their contrast is more obvious this way. Also, notice that money managers as a group increased their cash holdings and decreased their equity allocations last summer, just as the intermediate correction ended. Contrarian analysis would suggest that the current level of bullishness will be met by lower prices ahead.

Mutual Fund Flows
There are anecdotal signs that retail investors are tip-toeing back into the stock market after turning their backs to it for a few years:

U.S. stocks just posted back-to-back years of strong gains, yet the small U.S. investor largely remained a spectator. Now financial advisers say investors, many of whom rode out the financial crisis in cash and bonds, are slowly regaining confidence.

The stories are backed up by the money flow numbers. According to ICI the last week of the year saw inflows of $2.8 billion for equity funds. This was on top of the $3.7 billion from the prior week. But most of that was destined to foreign markets with very little staying in the US.

The data for the first week of 2011 from Lipper FMI shows a continuing flow into equity funds. Lipper reports a whopping $9.3 billion inflow for equities in the week of January 5th 2011 with most going to domestic funds ($6.86 billion). Of those, the majority in turn went into ETFs ($4.71 billion) which would explain the lack of inflows we are seeing from the ICI data since they only report mutual fund flows.

According to ICI the municipal bond market continued to see selling but with a little less intensity. The last week of 2010 had outflows of $2.8 billion which is less than the $3.5 billion and $4.9 billion of outflows it had the previous two weeks. In a quick reversal, investors are once again buying taxable bonds ($2.5 billion) after December 2010 saw two weeks of outflows.

Lipper reports that taxable bond funds received inflows of $2.93 for the week of January 5th 2011 while retail investors continued to rush for the exits in the municipal bond market with funds losing another $1.69 billion.

Option Sentiment
We’ve already explored the extremely bullish numbers in the ISE options market. So the fact that this week was even more extreme puts us in the real jeopardy of running out of superlatives. The 5 day average for the ISEE Sentiment index was 291 – meaning that for every 100 puts bought to open a trade, 291 calls were bought. This is slightly higher than the previous spike that occurred in mid December 2010. And it is a new record for this indicator:

The 10 day moving average of the ISEE was 255 – slightly lower than the peak in mid December 2010 (167). Since the CBOE’s (equity only) put call ratio is mirroring these extremes, my hunch is that they are a mirage created by the concentration of call buying in the financial sector. I’m continuing to analyse this to get a better idea of what is going on.

The 10 day moving average of the CBOE (equity only) put call ratio was little changed in its first trading of the year. We are still seeing about double the number of calls traded relative to puts. To put it similar to the ISE index, the week ended with 191 calls traded for every 100 puts.

That is definitely indicative of bullish option sentiment but it is clearly not as off the charts extreme as the ISEE itself.