Here’s this week’s overview of the sentiment landscape:
This week the bulls in the AAII survey of retail investor sentiment inched lower, falling to 46.6% while the bears fell to 25.6%. The bull ratio was basically unchanged from last week at 64.5% and remained at the midpoint of the high it achieved in late December 2010 (79%) and the low point it reached in late January 2011 (55%).
During previous momentum thrusts we have seen the bulls get truly exuberant with AAII readings approaching 70%. For examples of this, take a look at June 2003 and January 2004, each marked by a powerful rally with little or no corrections. In June 2003 we saw more than 71% of those surveyed bullish pushing the bull ratio as high as 89%. And in January 2004 the bulls almost reached 70% pushing the bull ratio to a high of 86%.
Clearly, we are not seeing that today, even after a breathtaking rally that has not stopped to catch its breath. What we are seeing is a relatively elevated bullish sentiment but a surprising lack of truly over-the-top excitement from the AAII bullish levels.
The II survey of newsletter sentiment this week was little changed with 52.2% bulls and 19.6% bears. Over the past few weeks, while the portion of bulls have slowly receded, the bears have remained relatively unchanged:
The previous AAII commentary comparing the momentum thrusts last seen in June 2003 and January 2004 holds true for this sentiment indicator as well. Back then the bull ratio spiked to +77% in each of those two instances and there were almost 4 bulls for every 1 bear in the survey for several weeks in a row. In contrast, during this cycle, we’ve only had the bull ratio reach a hgih of 75% and the maximum we’ve seen is 3 bulls for every 1 bear.
NAAIM Survey of Manager Sentiment
The NAAIM survey shows a slightly more bullish reading at 97% (median) from last week’s 96.5%. The average long exposure fell slightly to
84% from 86% last week. For a chart, please see last week’s sentiment overview.
Hulbert Newsletter Sentiment Index
Another measure of newsletter sentiment is showing a similarly elevated level of bullishness. This week the Hulbert Nasdaq Newsletter Sentiment index (HNNSI) once again rose to 73.3%. This metric is a good contrarian indicator because it tracks the more volatile Nasdaq market. In the past when it has reached 80% it has indicated a market top.
The last time was in early November 2010 when it was followed by a very short and shallow correction. In response the HNNSI fell quickly to 60% allowing the market to continue climbing. Previous to that the HNNSI spiked to 80% in late April 2010 and maintained that level into early May 2010. That was followed by a much more serious correction of course.
The Thomson Reuters/University of Michigan Consumer Sentiment survey for February is 75.1%, slightly higher than the previous month (74.2%). This preliminary number may be revised in the next few weeks at the arrival of the final number. Here is a chart comparing the consumer sentiment survey with the S&P 500 index:
The expectations sub-index weakened to 67.6% from 69.3%, after reaching a cycle high of 70% in January 2010. The current conditions sub-index is doing even better, reaching 86.8% (preliminary) – the highest since early 2008.
Gallup: Economic Optimism
A recent Gallup telephone poll of Americans in January finds that 41% believe the economy is “getting better”. This level ties for the highest level of optimism since the survey began in early 2008:
Crash Confidence Indicator
It has been a while since we checked in on this indicator. If you are unfamiliar with it, you can think of it as a “Black Swan” predictor. Individual and institutional investors are asked to cite the probability of a “catastrophic crash” of 10% or more in the next 6 months. A 0% response means that they believe it is not possible and a 100% response means that they are certain it will happen.
The Crash Confidence Index is those who believed that the probability of such an event is less than 10%. So the higher the Crash Confidence, the more confidence that there is no crash forthcoming and the lower it is, the more probable the perception of a crash.
While both institutional and individual investors have recovered from the crisis lows in March/April 2009, they have yet to once again reach the confident ways of years gone by. At the moment, they are neither confident nor despondent about the market. It is tempting to interpret this as a brick in the “wall of worry” that the bull market is climbing but looking at the history of this indicator, it is obvious that it is much better at pinpointing major market lows than market tops.
BofA Merrill Lynch Survey of Fund Managers
The Bank of America Merrill Lynch survey of fund managers shows that they are finally catching up to the retail investor excitement that we saw a few weeks back. The February survey shows bullishness at the highest level since the poll began in April 2001. A net 67% are overweight global equities – compared to 40% in December and 55% in January. Either managers are finally succumbing to the bullish case or they are afraid of being left in the dust as indexes beat them (or both).
The increased allocation to equities comes with the cost of reduced allocation to bonds and cash. Managers are now 66% underweight bonds compared to 54% in January. In fact, the gap between equity overweights and bond underweights is now at a record. Managers surveyed are underweight cash net 9% – the lowest allocation since January 2002.
Within their global equity portfolios, managers are concentrating on US equities with a net 34% overweight – compared to 27% in January and 16% in December. They are slowly increasing their exposure to European equities as well with an 11% overweight compared to a 9% underweight in January. Their favorite sector is technology (51% overweight compared to 39% in January) and least favorite are pharmaceuticals, financials, consumer discretionary, consumer staples and utilities.
Meanwhile, the exodus from emerging market funds that we noticed a few weeks ago has reverberated in this poll as well. The managers surveyed by Merrill Lynch are only overweight emerging markets by 5%. This decline from 43% in January makes it the biggest one month drop ever in the history of the survey.
Turning to monetary policy, the vast majority (85%) see interest rates higher in the next 12 months. And 70% expect the Fed to raise interest rates next year. Not surprisingly, rising commodity prices are mentioned as the biggest threat to the global economic recovery. A net 28% are overweight commodities as an asset class – compared to 16% in January.
Rydex Technology Sector
Retail traders that like to time the market with the Rydex sector funds are rushing into the technology sector. Mirroring the newsletter editors penchant for the technology heavy Nasdaq composite, these traders have added funds to the Rydex Technology Sector mutual fund pushing it to levels not seen since April 2010 and January 2010. As well, the surge in assets has swelled this sector in the Rydex family of funds to +25% of all sectors. So it seems that institutional investors (Merrill Lynch survey), newsletter editors (HNNSI) and retail traders are all very bullish on the technology sector.
Mutual Fund Flows
According to data from ICI, US mutual fund investors are returning to equities in a big way. The latest data for the first week of February shows inflows of $4.9 billion into US domestic equity funds. As well, January was a positive inflow month with a total of $6 billion net going into domestic funds. This was the first month of positive flows since April 2010.
International and emerging market equity funds which were receiving inflows before have now seen them reduced to a trickle (less than $1 billion). Taxable bond funds have returned to their normal pace with another $3 billion of inflow in the first week of this month. According to Lipper FMI, US equities mutual funds (ex ETFs) received $8.7 billion of inflows in the first week of February.
According to a recent survey by Fitch Ratings, European fixed income managers expect their popularity to wane this year compared to last year. More than 67% of those polled expect a significant drop in inflows this year, after seeing $25 billion redeemed from bond funds in December 2010. And 6% expect net outflows with the money instead going into equities, gold and cash.
Municipal Bonds Flows
According to ICI, municipal bond funds are continuing to see withdrawals with another $1.4 billion redeemed out of the sector. Lipper reports municipal bond funds losing $947 million, their 14th straight week of net outflows. Municipal bond ETFs in contrast had a very small inflow ($93 million).
The Financial Times reports that several hedge funds are casting about searching for a way to short municipal bonds. The crisis in this sector has brought out bargain hunters like David Kotok of Cumberland Advisors but it has also attracted the attention of opportunisitc funds that wish to profit from the troubles of specific cities and states. The problem is that borrowing munis is almost impossible as they are held in individual accounts and mutual funds. The CDS market is also tiny and illiquid. As before, I continue to see more opportunities to go long in this sector as I believe the general risk of default is overblown.
High Yield Bonds
Junk bonds continue to benefit from a seemingly insatiable appetite from yield hungry investors. I mentioned last week that the yield on the benchmark Merrill Lynch High Yield Master II Index had fallen to a pittance. This week it fell even more to 6.873% – this is slightly below the previous low of 6.863% reached in December 2004.
The risk premium (above Treasury yields) is now more than double what it was in May 2007. Historically, this premium has accounted for 57% of the total junk bond yields but now it accounts for almost 67%. But it may not be enough to reach a critical level. Here is a chart showing the spread between the ML High Yield index and Treasuries:
Source: FT (US Junk Bonds)
The dominant asset class in US investor portfolios continues to be bonds and cash equivalents. This shows the overall reluctance of the average American to venture back into equities. And it is especially odd when we consider the interest rate environment established by the Fed to force everyone into riskier assets.
Source: Fidelity Investments
In 2000 most thew caution to the wind and reduced bonds and cash equivalents in order to invest in equities. In contrast, in 1982 everyone was fearful and holding a large amount of cash. Of course, back then interest rates were much higher so there was an incentive to hold cash, even after inflation. Right now US households are somewhere in the middle of those two extremes.
Since taking an opportunistic long in gold late in January, gold and gold stocks have recovered nicely from their correction. Gold sentiment continues to be accommodating a continuation of the move higher with most sentiment indicators recovering from their recent lows and following gold prices higher.
That call was short term in nature. Turning to a more long term perspective, the Chinese are fast becoming voracious gold buyers according to a recent Reuters article. Industrial and Commercial Bank of China (ICBC) reports that the sold 7 tonnes of physical gold to their clients this past January. To put that in perspective, consider that in all of 2010 they sold 15 tonnes of gold!
As well, ICBC is meeting the demand with an investment vehicle that allows their clients to invest in gold via a term deposit linked to the price of gold. Culturally, China, just like India has an affinity for gold but they are just now starting to become wealthy enough to accumulate it. And unlike the Chinese real estate market, the government is more than happy to see this buying frenzy continue.
Option Market Sentiment
The option market continues to be marked by an overall bullish bias. The (equity only) ISE Sentiment index finished the 10 day average at 230 – unchanged from last week. Since we’ve spent so long at these levels (and higher when it made a double top) it is easy to forget that this is a bullish extreme. But of course the market doesn’t seem to care, or at least it hasn’t yet.
The CBOE (equity only) put call ratio is showing a similar level of bullish bias. If we convert the 10 day average for the CBOE put call ratio it is slightly less than the ISE index at 185. But still, at almost double the number of calls to puts, it is clear where the consensus is.
Last week I showed a chart of the open interest for the OEX put call ratio. This indicator has continued to move into even more extreme territory this past week. The 10 day moving average finished the week at 1.52. We haven’t seen it this high since December 2007. As well, the steep rise tells us that there is a complete change of tone from the smart option traders. Here’s a long term chart showing the 10 day moving average of the open interest ratio to the S&P 100 index itself:
The 10 day moving average of the OEX put call ratio rose to 1.45 from 1.30 last week and the OI ratio climbed to 1.52 from 1.31 last week. As I mentioned before, the combination of these elevated levels of put activity coupled with the sudden change in tone after months and months of supportive call buying should be of concern.