Sentiment Overview: Week Of March 11th, 2011

My apologies, this week’s sentiment was delayed due to travel and prior commitments:

Sentiment Surveys
The weekly AAII survey of US retail investors shows a continuing deterioration in bullish mood. This week those believing that the stock market would be higher 6 months from now fell to just 36%. That’s the lowest since early September 2010. The pessimists were relatively unchanged at 32.3% providing a bullish ratio of 53%. So the overall picture from this indicator is one of diminished enthusiasm after its spike in late December 2010.

Investors Intelligence
The survey of newsletter editors this week was also little changed. The bullish camp continued to eke out the majority with 52.2% – bringing us to the 17th consecutive week they have done so. The bears were little changed at 21.1% from last week’s 19.5%. The bull bear ratio remains stuck within a narrow band and this week it was 2.5:1.

Last week we also looked at the Farrell Sentiment Index which was a re-working of the AAII survey results. Since a reader suggested that it made more sense to apply Farrell’s calculations to the II survey instead, here’s a chart:

The Farrell Sentiment Index you may recall takes the bullish reading and divides it by the bearish reading plus half of the neutral reading. Instead of the AAII it makes more sense to apply it to Investors Intelligence because unlike the AAII survey questions, the II’s third option is not ‘neutral’ but ‘correction’, implying a correction of at least 10%. So it is entirely plausible that Doug Kass made a mistake when he applied the formula to the AAII results.

To make our case even more persuasive, last week the Farrell Sentiment Index fell below 1.50 (to 1.47 from 1.63) which was the demarcation point of a sell signal as mentioned by Kass. The last time it gave a similar sell signal was in mid-May 2010 and before that in January 2010. Both of those were accurate signals.

NAAIM Survey of Managers
The survey of active money managers showed the same sort of vacilation we’re seeing from the other sentiment surveys above. The average climbed higher again to 75% (from 70% last week) while the median went up to 77.5% from 75% last week.

As well, the responses are once again clumped together indicating that while nervous to not be too optimistic, active managers polled are more or less of one mind: the market is going higher.

Consensus
The Consensus Bullish percent inched higher this week to 76%. That is clearly at a bullish extreme compared to its long term historical pattern. As well that is the highest level we’ve seen since April 2010 when the equity market last made a major top.

IBD/TIPP Optimism Index
The Investor’s Business Daily Economic Optimism Index fell this month to its lowest level since October 2008. The drop was the second largest single month drop since the start of the survey in 2001.

The Optimism Index fell to 43 from 50.9 in February. The IBD/TIPP is considered by many as the canary in the coal mine for other consumer sentiment surveys which are released later in the month.

Michigan Consumer Confidence
The early IBD/TIPP accurately presaged the University of Michigan Consumer Confidence report which showed a dramatic fall in March from 77.5 in February to 67.6 in March. So we are back to exactly where Consumer Confidence stood back in September 2010.

Even more notable while the Current Conditions sub-index fell just a tad, the drop in the Expectations sub-index was alarming. It fell to 58.3 from 71.3. This is the lowest level since March 2009 and clearly shows that the persistent unemployment and the sharp increase in gas and oil prices is having an serious effect on consumer sentiment.

Schwab Survey of Advisers
A recent survey sponsored by Charles Schwab (SCHW) shows that independent registered investment advisers have increased their optimism along with the recent market gains.

Of the 1300 advisers polled on behalf of Schwab, 56% were bullish and only 10% were bearish (over the next 6 months). Advisers are coming back to equities and especially US equities. For the S&P 500 index, 77% of advisers expect equities to rise – compared to 63% in July 2010, when the survey started. But keep in mind that by the nature of their work advisers are a bullish bunch as they win when they are able to accumulate assets.

Advisers also have a rosy picture of the US economy with 68% expecting consumer spending to increase in the next 6 months. They are not worried about unemployment with only 17% expecting it to increase.

As we’ve been monitoring through the Rydex Advisor Index, the space between investment advisers and retail clients is a chasm.

TrimTabs Barclay Survey of Hedge Fund Managers
According to the latest TrimTabs survey of hedge fund managers there has been a noticeable shift in their views on US equities (S&P 500 index). In February 39.5% of those polled were bearish and 25.6% were bullish. In January the results were basically switched with 37.4% bullish and 26.4% bearish.

So in February there were more pessimists than optimists, something we haven’t seen since November 2010. Their views on other asset classes such as the US dollar (neutral) and 10 year Treasuries (bearish) as well as the extent of leverage used were not significantly different from the previous month.

Interestingly enough, 25% of 89 hedge fund managers polled are bracing for oil to climb to $150 or more. TrimTabs feels the contrarian mojo juices flowing and compares the current situation to the 2008 oil spike. They also point out that such a rise would represent an almost 7 standard deviation move, implying that it would be more of a short-term exhaustion spike than a longer term move. Personally, I’m inclined to agree with such a contrarian interpretation.

Mutual Fund Flows
According to ICI, US mutual fund flows were dominated this week by outflows from equity funds and inflows into bond funds. More specifically, $3.1 billion was redeemed from domestic mutual funds while an additional $1 billion was added to international funds. This was the 12th consecutive week that domestic funds inflows have outpaced foreign fund inflows. Keep in mind that this is preliminary data that will be adjusted slightly going forward.

In contrast, retail investors added an additional $4.8 billion to taxable bond funds this week. The love affair of retail investors with fixed income (and to a lesser extent with foreign funds) is well documented and persistent so it is not surprising to see it continue. But this was the first week since the beginning of the year when there were net outflows for US focused mutual funds. The first week of January this year saw appx. $4.2 billion leave domestic funds and about $2 billion a week was redeemed in December 2010.

Data from Lipper FMI, another source of fund flows for US mutual funds, shows a slightly different picture. This week Lipper reports an additional $894 million net inflows for US domestic funds and $623 million net inflows for foreign funds. As well, there was a net inflow of $4.7 billion for ETFs into general equity funds. Their data for the weekly net inflow into taxable bond mutual funds matches the ICI data at $4.6 billion.

Leveraged ETF flows
For the month of February $355 million flowed into US equity leveraged short ETFs (compared to $650 million in January 2011). Meanwhile a net $201 million was withdrawn from US equity leveraged long ETFs (compared to $558 million in January 2011). According to research from TrimTabs leveraged ETF flows are one of the best contrarian indicators for the equity market.

Long Term Fund Flows
Stepping back from these myopic weekly readings, the overall picture is a dubious one for equities. Since January 2007, a cumulative total of $311 billion has been sucked out of all US equity mutual funds (according to ICI). An in its stead, more than $766 billion has been funneled towards bond funds (both taxable and municipal tax exempt).

Within a short to medium term time frame, outflows can be interpreted through contrarian prism. For example, the recent municipal bond crisis (see below for more on that). But when we see a persistent trend like this, it serves to sap the strength of the market. But keep in mind that this is for just mutual fund flows. While ETFs have been taking a larger and larger role in retail investment portfolios over the years, they still lag in terms of size to mutual fund holdings and flows.

Municipal Fund Flows
The muni bond market is still seeing some residual selling as a consequence of the much bigger panic that we saw cascade from November 2010 into the new year. This week, according to ICI, an additional $711 million was redeemed from municipal bond funds (compared to $557 million last week).

According to data from Lipper FMI, retail investors sold $512 million this week from the municipal bond fund sector (compared to $989 million last week and $588 for the week before that). The 4 week average of the Lipper FMI outflows for municipal funds is the lowest since mid-November 2010 – when the recent municipal crisis was triggered with lower prices and TV talking heads mentioning “default” for the first time in decades.

municipal bond issuance chartWhile the municipal bond market may have stabilized here, that is due to the counterbalancing force of not just new demand from hedge funds and fixed income investors not really interested in the tax benefits of municipal bonds, much of the credit should also go to the restricted supply. Municipal bond issuance is on track to skid to a quarterly record low not seen in 11 years (WSJ article). As well, in reaction to the recent volatility, the Municipal Securities Rulemaking Board is expected to come out with fresh guidance to increase disclosure by delegating it to the broker-dealers.

Finally, bond guru Jeffrey Gundlach was in the news again, this time at CNBC, with warnings of impending doom for the municipal bond market. He isn’t definitively bearish on them as an asset class but the tone of his comments are decidedly negative without having any specifics. A few weeks ago Gundlach was prophesying doom over at Barron’s. And it was last month that Chanos was sounding negative on municipal bonds as well.

Emerging Market Fund Flows
For details on foreign market outflows, check out this report from JP Morgan.

http://www.scribd.com/doc/50216401/J-P-Morgan-Herd-Instinct-4-Mar-2011

Junk Bond Funds
High yield bond funds continue to attract a lot of attention and money from investors. This past week they attracted $574.2 million in net inflows compared to $131 million last week. The Merrill Lynch High Yield Master II index is continuing to trade at a lofty level hitting 103.90 cents on the dollar this week, relatively unchanged from last week. The index is averaging a yield of 7.04% – 471 basis points above risk free US government bonds.

Option Sentiment
The option market continues to exhibit the same characterstics that I’ve been pointing out for the past several weeks. So at the risk of sounding like a broken record, I’ll keep my comments brief.

The CBOE and ISE Sentiment index are both showing relatively unchanged put/call activity. Of course, they are both still showing a definitive preference for call buying as traders attempt to position themselves for further gains.

The CBOE equity only put call ratio (10 day moving average) closed little changed from last week at 0.60 while the ISE sentiment index (10 day moving average of the equity only call put ratio) closed at 184. Converted to a put/call ratio it was 0.54 so very similar levels of call buying for both markets.

On the other hand, the S&P 100 index (OEX) aka “smart money” option traders went into berzerker mode as they devoured put options to position themselves for a market decline. The daily put/call ratio for the OEX declined slightly but the open interest ratio went through the roof, reaching 1.76 – a level we haven’t seen since February 2007:

Going back more than 10 years (not shown on chart) there were only 4 other instances when the 10 day moivng average of the open interest put/call ratio for OEX options went above 1.75. These were June 2003, February 2004, November 2005, and February 2007. The first three were indicative of a plateau. The last one was an early warning signal of the major market top in 2007.

It may take some time but this reliable indicator has been able to tell us about both important sell areas and important buy areas. Right now it is clearly indicating a very top heavy market.

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4 Responses to Sentiment Overview: Week Of March 11th, 2011

  1. John F. says:

    There was a big drop in Feb 2007, but then price fought back a few times before the actual top. Feb 2007 was not the top, Oct 2007 was the real top. there was actually a substantial rally from Feb 2007 to June 2007 (200 point rally).

  2. liverpool68 says:

    Great material. Do you have any earlier history on the Cumulative Mutual Fund Flows? Would be good to see what it did before 2007.

    • Babak says:

      Yes, it would be interesting to see more data. I’ll see if I can share a more long term one for this week’s sentiment overview. Thanks for the suggestion.

  3. PEJ says:

    Thanks Babak. Great work as usual.

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