Prices Are Not the Only Thing in Rarefied Air
Not only does the market write the news, it also manages to convince people that it is best to buy when prices are high and a really bad time to buy when they are low. At the March 2009 low, the daily sentiment index (DSI) of stock index futures traders reached 3% bulls – a record low. Bears exceeded bulls comfortably in numerous surveys, such as the II market newsletter writer poll. Not surprisingly, it turned out to be the best time to buy since the low of July 2002.
Today the exact opposite situation obtains in every respect. Not only are prices higher than ever before – so is the bullish consensus. We didn't think it possible that this would happen, but in several measures the consensus has turned even more bullish in the final weeks of 2013 than it was at the peak of the Nasdaq bubble in early 2000. At the same time however, declining breadth momentum continues to be in evidence:
NYSE index vs. McClellan Oscillator – click to enlarge.
First a look at the options speculation index – this index measures the ratio of opening transactions in bullish vs. bearish positions at all options exchanges combined (this means: put selling and call buying are considered bullish, put buying and call writing are considered bearish positions).
This is only the second time this index has reached a comparable extreme. If it were the only such indicator at a new high it could be seen as an outlier, but it isn't - click to enlarge.
The next chart shows the bullish consensus of all stock market newsletter writers as of November 2013. It has hit a new record high twice in 2013 (at least it is a record high since 1997, which is how far back the data go). This jibes with the II bull-bear ratio recently reaching the highest point since the summer of 1987.
According to newsletter writers, there has never been a better time to buy! It probably won't surprise much that their bullish consensus was below 10% in the depths of the 2008 crash, and at just around 15% at the final low in 2009. Admittedly this measure is quite volatile, but new record highs are definitely worth noticing – click to enlarge.
In late 2013, the Rydex bull-bear ratio also streaked to a new high at 6.5 – note that it has since pulled back to just below 5 (still extremely high historically), as there has been a quite sudden large outflow from Rydex bull assets. The leveraged funds ratio even went to an unprecedented 12.5 and has suddenly collapsed to below 6 in early 2014. These moves likely represent a withdrawal on the part of smart money traders. Note that previously, the leveraged ratio tended to peak out just above 4, but it has marched to progressively higher levels in the course of 2013. In other words, in spite of falling by more than 50% from its peak, it remains at a level that would previously have been considered quite excessive.
Even more reliable as a contrarian gauge may be the level of Rydex money market funds as a percentage of total assets. This measure tends to align very nicely with major lows and highs – whereby there is slightly more precision when lows are made, as it tends to spike into lows, whereas it tends to make 'rounded' bottoms near major peaks. The Rydex money market fund percentage recently fell to its lowest level since 2001. To this it must be remembered that in 2001, traders tended to buy heavily into several short term rallies as the memories of the expired bull market of the 1990s still lingered.
Rydex bull-bear ratio: the late 2013 rush not to miss out … - click to enlarge.
Rydex money market fund percentage – in late 2013, a new 12 year low was hit - click to enlarge.
Not surprisingly, the NAAIM survey of fund managers has been totally 'bear free' for six weeks in a row. Currently the most 'bearish' manager in the survey is 25% net long (responses range from 200% net short to 200% net long, i.e., leverage is considered as well). The most bullish managers have been 165% net long for four weeks running (and 163% in the two weeks before that). The average across all managers adds up to 95% net long, down from over 100% in mid November. Keep in mind that this group is usually quite correct during trends, but has a tendency to be spectacularly wrong near major turning points.
The NAAIM survey average over time - click to enlarge.
A table showing disaggregated responses to the NAAIM survey since the end of October. Over the past 6 weeks not a single respondent has been short, and most recently the lone 'bears' were 25% net long (down from 50% in the previous week). The biggest bulls have been almost maxed out at over 160% net long for six consecutive weeks. Booyah?
Conclusion:
Stock market sentiment is quite in keeping with the anecdotal sentiment detectable in articles discussing the 2014 outlook in the financial press. Hardly anyone considers the current market environment to pose any downside risks. In fact, the only people warning about such risks are almost certain not be listened to, as they have been wrong for quite some time (not wrong about the existence of risk, but they have missed a spectacular 2013).
This latter fact speaks in favor of the trend-following model our friend and guest author Frank employs (which by the way according to the most recent communication still remains long – it recently missed a 'sell' by just a smidgen. We will advise readers when the model changes its mind and flips to selling the market).
Anyway, we are wondering how much longer the 'nothing can possibly go wrong' atmosphere can be maintained. A great many indicators seem to be saying that market participants are 'all in'. That said, money supply growth continues at what is still a historically strong pace, but keep in mind that it is slowing down. For a while such a slowdown is likely to be ignored by the market, but the lead and lag times are highly variable and there is no way to apodictically state that a certain time must pass or what the specific growth threshold is that will upset the apple cart if it is undercut. Note that we are assuming that Western central banks and banking cartels are not (at least not yet) willing to 'go Weimar' on us. In fact, the recent tapering announcement suggests that worries are growing that things might be getting a bit out of hand. It seems to us that 2014 is likely to be a lot more volatile than last year, but keep in mind that we have said the same thing about 2013, so this assessment cannot be relied on. Once the market suffers a setback, it will be interesting to see if opinions change again as quickly as they did in the 2011 downturn, or if bullish sentiment has become ingrained.
Charts by: Sentimentrader, Decisionpoint, StockCharts, table by NAAIM