Trader’s Narrative

Here is this week’s overview of various sentiment data for the financial markets:

Sentiment Surveys:
Last week the AAII’s weekly sentiment survey finally dipped into a bearish level as the bull ratio fell below 30%. This week the AAII poll of US retail investor sentiment showed a quick recovery from those doldrums: 31% bullish and 42% bearish.

Since 2007, the average bull ratio is 47% so at 42% we are very close to a ‘normal’ sentiment reading with this week’s results.

Investors Intelligence
Whereas the retail investors became concerned about a prolonged stock market decline last week, newsletter editors suddenly were gripped with the same fears this week. The bulls fell to 29.4% while the bearish camp swelled to 37.7%.

This week was the first time since March 2009 that the number of optimists from the II fell below 30%. There is no question that the current Investors Intelligence reading is at an extreme which can be interpreted from a contrarian viewpoint to have bullish consequences for the stock market.

In the past 20 years, we’ve only seen the II bulls dip below 30% a handful of times. And each of those has been great buying opportunities in the medium to long term. But keep in mind that this does not forestall some potentially wicked retracements along the way.

NAAIM Survey of Manager Sentiment
The NAAIM sentiment survey which tracks active money managers was little changed this week. The median exposure to equities remained at 50% long for the 3rd consecutive week. Meanwhile the average long exposure increased slightly from 44% last week to 53% this week. So overall, it seems that active managers polled by this survey are reluctant to drastically change their stance and instead are taking a wait and see approach.

Analyst Sentiment
According to Bloomberg data covering 159,919 recommendations, for the first time since 1997 analyst “Buy” recommendations have fallen below 29%. The strange thing is that while analysts are turning more pessimistic, they are upping their S&P 500 earnings estimates.

In analyst speak, a “Sell” is extremely rare and a “Hold” is a synonym for sell. So it is shocking to see the combined “Sell” and “Hold” percentage for US stocks rise to 71% (as of last month). The pessimism pervades international markets as more than 54 percent of ratings for companies in the US, UK, Japan and Brazil are “Hold’s” - that is the highest level since Bloomberg began measuring the data in 1997.

This would be contrarian bullish for stocks, of course. An alternative explanation is that with correlation among stocks and the S&P 500 index extremely high, analysts are reluctant to put their reputation on the line. With the index determining the vast majority of the performance of individual stocks, there is little incentive for analysts to forecast which will beat the index.

Hedge Fund Sentiment
According to a TrimTabs/BarclayHedge survey of hedge fund managers, only 17% were bullish on the S&P 500 index in August. And an increasing number, 47%, had an outright bearish outlook for equities:
Continue reading ‘Sentiment Overview: Week Of September 3rd, 2010′

The following is a guest post by a buy-side analyst working in a US asset management firm. The author’s comments are in italics. I welcome you feedback in the comments:

• Change in Nonfarm Payrolls: Survey -105K Actual -54 Prior -131 Revised -54
• Change in Private Payrolls: Survey 40K Actual 67 Prior 71 Revised 107

Private Payroll Formation coming off the trough of the recession

• This recession is actually tracking previous recessions in terms of adding Private Payrolls. Total Payroll formation lags a bit, but is also tracking fairly close. Overall, today’s payroll report is a good one, although the manufacturing payrolls are a bit of a conundrum (particularly in light of the ISM numbers earlier this week). Ten year yields immediately jumped ~11 basis points as the bond market priced in higher growth.
• Change in Manufacturing Payrolls: Survey 10k Actual -27 Prior 36 Revised 34
• Unemployment Rate: Survey 9.6% Actual 9.6 Prior 9.5
• Avg Hourly Earnings: Survey 0.1% Actual 0.3 Prior 0.2
• Avg Weekly Hours: Survey 34.2 Actual 34.2 Prior 34.2
• The Coast Guard is investigating the cause of a fire on an oil platform in the Gulf yesterday. The fire started in or near the living quarters, according to a Coast Guard spokesman, which means it may not have been related to the platform’s operation. Yesterday, the news of an explosion and fire drew parallels to the BP disaster. It turns out there was no explosion, however. Still, Bloomberg News says industry watchers fear the accident may end the industry’s hopes for an early end of the deep-water drilling moratorium. The WSJ says Mariner Energy has a history of fires and violations, which reinforces the Administration’s argument for a thorough reexamination of regulations and procedures.
• The WSJ says Afghan President Karzai’s brother, the largest shareholder in Kabul Bank, is in the US to back the bank to stop a run which has already depleted a third of the bank’s deposits. A spokesman for the Obama Administration says a team of experts has been dispatched to advise the Afghan central bank, but there are no plans to support the Kabul Bank itself. – WSJ
• The Administration is considering a permanent extension of the research and development tax credit, according to Bloomberg News, in addition to a payroll tax holiday, a small business tax cut and additional infrastructure spending as part of a second stimulus package expected to be proposed in the fall. – FTN Financial
• US equity technicals (from M. Krauss) - Two strong days have now entered 1091-1108 near term resistance, after Wednesday’s 1040 two-week base breakout above 1065. Bears if below 1065/1055. Holding 1040 into early-October would generate a 1150-1200 Christmas present for the bulls. To us, Aug’s 1129 to 1040 decline was a corrective ABC, not an impulse of a new bear market.
• BP oil spill – BP has said that its costs to date due to the Gulf spill amount to ~$8B. Bloomberg
• European Central Bank President Jean-Claude Trichet adopted a more hawkish tone at yesterday’s monthly press conference than last month. The head of the Governing Council said, “Risks to the outlook for price developments are slightly tilted to the upside.” In August, the ECB wrote that “Risks to the outlook for price developments are broadly balanced.” – Bloomberg

US Unemployment Rate – 1980 to present

The following is a guest post by a buy-side analyst working in a US asset management firm. The author’s comments are in italics. I welcome you feedback in the comments:

Initial Jobless Claims: Survey 475K Actual 472 Prior 473 Revised 478

• August shipments grew 16.5% YoY, meaningfully accelerating from the 8.9% growth in July, with the 3-month moving average pushing up to 14.7% from 12.8% (in July). In other words, the levels of freight in the US grew faster YoY in August…countering those concerned that US economy decelerated further in August. We continue to view the current period of economic weakness as a “growth scare” rather than a double-dip. Recent ISM data is also supportive. But obviously, the labor report Friday would need to show continued improvement in hours worked to support this and hopefully, some positive labor growth as well. We still see a Beta rally in the Fall. – JPM Research

• China’s PMIs Signal a Moderation, Not a Hard Landing - Data collected by the Chinese Federation of Labor showed that the PMI rose slightly to 51.7 in August 2010 from 51.2 in July. The increase, which broke a three-month decline, is still close to the weakest recording in 18 months and well below the 55 average of late 2009 and early 2010 when China was expanding above potential. All subindexes have slowed, which indicates that the pace of expansion has cooled. – RGE Monitor
• US Industrial Production Rises; Mixed Signals From Regional Surveys - The Institute for Supply Management manufacturing index showed expansion in activity for the 13th consecutive month in August 2010, following an 18-month period of contraction that lasted through July 2009. The pace of expansion in manufacturing rose for the first time in four months as the PMI rose to 56.3 from 55.5 in July, returning to its June level. The ISM index of manufacturing employment also indicated improving conditions. – RGE Monitor


The thinking is that a stronger ISM could indicate that recent weakness is just a soft patch and GDP and payroll data will rebound accordingly.

• Greece, Italy, Japan and Portugal are the advanced economies hovering closest to unsustainable levels of government debt – new IMF study – Bloomberg

The following is a guest post by a buy-side analyst working in a US asset management firm. The author’s comments are in italics. I welcome you feedback in the comments:

• Credit Demand May be Achilles Heel of U.S. Economy – One of the most influential gauges of bank lending in the U.S. economy suggests that the credit crunch is over — at least for now. Most of the data compiled as part of the recent Federal Reserve Senior Loan Officer Opinion Survey shows supply of credit – banks’ willingness to lend and the terms and conditions that they are willing to lend at – is easing, even if only modestly. – Bloomberg

• One of the key findings of the 2010 Best Places to Work in the Federal Government survey is that worker satisfaction is more profoundly affected by perceptions of top management than by immediate supervisors. – WP
• White House weighing new measures to spur economic growth – among the options being considered are tax cuts (”possible payroll tax cut for businesses and individuals, as well as other business tax breaks”) and a new nationwide infrastructure program; the White House economic team has met “frequently” in recent days to consider options for the economy. Congressional leaders don’t see much happening however until after the mid-terms are out of the way. WSJ
• Forex trading volumes soar to ~$4T daily; this $4T number is 20% higher than in 2007, the last time a survey of the market was taken (according to the BIS) – WSJ
• Departing White House economist C. Romer calls for more action to spur growth - “We have tools that would bring unemployment down without worsening our long-run fiscal outlook, if we can only find the will and the wisdom to use them,” Romer said in excerpts from a speech she will deliver later at the National Press Club. Reuters
• Obama small business tax cuts to pass - Democrats have lined up enough support to pass the small-business bill the Senate has been considering, said Jim Manley, a spokesman for Senate Majority Leader Harry Reid (D., Nev.). WSJ
• Obama speech Tues night; overall nothing incremental that hadn’t been talked about in the press in the days leading up to the talk; the president did say he would make it is priority to get the US economy back on track (CNBC)
• A better-than-expected increase in home prices isn’t likely to have staying power. – Bloomberg

• The market is up ~2.5% on the back of better than expected PMI data out of China and ISM manufacturing here in the US. Below is an overlay of ISM & GDP, showing that a healthy ISM Manufacturing number is important to the economy:

This is a guest post by Ian Dogan of Insider Monkey, it originally was published at his blog and is being republished here with his permission:

I started doing this as a joke and did not expect to find a way to make money with Roubini Sentiment Indicator. Nouriel Roubini, a.k.a Dr. Doom has recently been stating that he is not Dr. Doom but he is Dr. Realist despite the fact that he is on TV mostly when things are going wrong, volatility spiking and stock market going down. You can clearly see this pattern from the graph below:

I gathered the Roubini sentiment index from weekly values provided by Google Trends. A simple correlation analysis shows that Roubini sentiment index has a negative correlation of (0.68) with the market and a positive correlation of 0.82 with the VIX. Some might dismiss the Roubini sentiment indicator because of its high correlation with the VIX, thinking that Roubini’s popularity is caused by the increase in VIX. Before jumping into any conclusions, we need to answer the following question: What is the exact nature of the relationship between VIX and Roubini Sentiment Indicator? If VIX is leading Roubini Sentiment Indicator, then you could rightly claim that Roubini is merely a parasite exploiting the increased fear in the marketplace. If the two indices are coinciding then Roubini is merely expressing what the market is thinking, hence he is truly the Dr. Realist or maybe Dr. Journalist?

On the other hand, if Roubini Sentiment Indicator is leading the VIX, then it might be the case that Roubini is spreading the fear like the plague and causing the spikes in VIX and declines in the market. In this case, he is the dreaded Dr. Doom. Take a look at the graph of Roubini Index vs. VIX and see the high correlation yourself.

How do we test our hypothesis about VIX and Dr. Doom, I mean Roubini? Granger Causality Test is the perfect tool for this job. We use VIX as the dependent variable and lagged values of VIX and lagged values of Roubini index as independent variables. So the idea is if lagged values of Roubini index can explain the movements in VIX in the presence of lagged values of VIX, then we can say that Roubini index is Granger causing the VIX (we run some other tests to make this claim, I don’t want to bore you with the technical details). We also test whether VIX Granger causes the Roubini index. Our test results clearly show that Roubini Sentiment Indicator Granger causes the VIX up to two weeks in advance with a very high degree of statistical significance. Naturally VIX does not Granger cause Roubini index. Roubini is indeed the Dr. Doom and maybe he should be put away for the sake of our economic recovery and millions of unemployed workers.

Maybe not. Since Roubini index is a leading indicator of an imminent spike in VIX and usually spikes in VIX come with a decline in stock market, we can develop a profitable trading strategy around this finding. Hey, I have a full-time job and did this quickly for fun, so the strategy I will present now may not be refined enough. However, it is good enough for a modest blog post. Here is our simple trading strategy: Go long the VIX when Roubini Sentiment Index goes %25 above its four-week moving average. Following this strategy over the 2007-2010 period will earn us a weekly average return of an amazing 2.4% (If we had simply gone long VIX at all times, the average weekly return would have been 1.6%). If we hold on to our long VIX position for three weeks, the average return over this time period is 8.25%. Dr. Doom has been sitting on a huge pile of gold all this time, yet he does not trade (Would it be insider trading if he traded based on what he is going to say on TV the next day?). Google guys could also utilize Roubini index in real-time and trade profitably

Another trading strategy is shorting the SPY when Roubini Sentiment Index is 25% above its 4-week average. In this strategy when we keep our short position for three weeks, SPY declines an average of (1.6)% over three weeks. Normally the average weekly decline in SPY is only (.06)% from Jan-2007 to Aug-2010. It is really interesting that we can make money by using Roubini Sentiment Indicator.

What does the Roubini Sentiment Indicator tell us lately? The latest value for Roubini Index is 2.2 and it is more than 25% above its 4-week average. The latest reading was from Aug 22nd. So this means that the stock market is expected to decline by an average of 1.6% between Aug 22nd and Sep 12th. Of course stock market losses would be much higher if Roubini shows up on CNBC tomorrow and scares the bejesus out of investors

Disguised Advertising: This article is brought to you by insidermonkey, which is going to be your source for free real-time insider trading data. At least, we hope so. We also aim to educate ordinary investors and give them the tools to help them make informed decision. Again, we hope so. Come back in a few days, and I will present another interesting and entertaining article. Btw, I have a Ph.D. in financial economics with a focus in insider trading. Maybe you will come back for serious articles on insider trading.