Market Indicator for the Week Ahead
October 10, 2011
Introduction of Sentiment Polls
Sentiment analysis is an important area of market trading decisions, therefore tracking of sentiment polls becomes essential to determine the direction of market movements.
By looking at various surveys and comparing their methodologies, we see what they're telling us about how investors feel right now. This survey methodology is important to all traders, whether you are contrarians, a conformist or, anywhere-in-between.
Obviously, contrarians consider high levels of pessimism to have bullish implications for the market. Negative sentiment signals the presence of sideline money, as well as the potential for quick, big gains when that money begins buying into the market. Of course, the bullish implications are most valuable when the widespread pessimism runs counter to the market's direction.
The Investors Intelligence (II) poll, one of the oldest sentiment polls, being around a long time; has actual data dating back to the early 1960s. To conduct this poll, II gathers various publications on the market and determines their stance. Then, they show the percentage of financial advisers who are bullish, bearish or expecting a correction (i.e., short-term bearish, but longer-term bullish).
Below is a chart of the percentage of bulls and bears from the II poll going back to 2009. It shows the bears are currently at their highest level since the March 2009 bottom. Accordingly, the bulls are low -- but the percentage was actually lower in August 2010. That August pullback in the S&P 500 Index (SPX) was actually a higher low, as the market was up from a month earlier. However, it really freaked out investors, which was a sign that pessimism was rampant and a rally possible.
Therefore, pessimism is evident in the latest II poll -- but at the time the survey was conducted, the market was hitting fresh lows. So, that diminishes the bullish implications.
AAII stands for the American Association of Individual Investors. Each week, they ask their membership where they think the market is heading in the next six months. Then, they group those responses into three categories -- bullish, bearish, and neutral -- and report the percentage for each.
As you can see from the chart below, as one of the sentiment polls, it is a lot more volatile than the Investors Intelligence (II) poll. That makes sense, as those who actually publish their market outlooks would probably be more stubborn about changing their opinion than those who are informally asked every week, "Where are we headed?" In fact, the poll was so volatile from about April 2009 through mid-2010 that it was nearly useless.
In late 2010, the bulls climbed to pretty high levels, while the bears fell to very low levels. The market still had some room to the upside at that point, and continued to rise through February 2011. After that, the SPX pulled back significantly and became quite choppy. The index then hit an annual high in May, and we're down significantly since then. Currently, the bears are at a pretty high level, but the bulls are not at their annual lows, and are actually rising.
This is one of the newest sentiment polls, which has data going back to only July 2006. NAAIM stands for the National Association of Active Investment Managers. What sets this poll apart from the rest is that this poll does not simply ask, "Are you bullish or bearish?", but instead asks money managers how their money is actually positioned in the market.
They can answer anywhere from -200 (leveraged short) to +200
(leveraged long). This is valuable information, because the fundamental goal of our sentiment analysis is to see where money is positioned. Is it all crowded into the market, or all on the sidelines (or somewhere in between)? This poll asks that direct question.
There are some drawbacks to this poll, which NAAIM acknowledges on their site. For starters, it's not easy for some money managers to sum up their position in one simple number. Also, the sample size for this poll is growing, but it's not very big as of right now.
Below, the chart of the NAAIM survey shows that it is currently at its lowest reading of all time, and is negative for just the second time ever (the first time was in October 2008, around the peak of the financial crisis). This suggests that money managers are short the market -- so any positive news that comes out, or any signs of life in the market, could spark a fast and furious short-covering rally.
Each of the sentiment polls mentioned above are showing significant pessimism at the moment. This is to be expected, with the SPX down almost 15% since July. A positive catalyst could change the hearts of these bears, and the market could make a significant move higher. However, the overall price trend is lower, which diminishes the contrarian bullish connotations of the polls. Also, as far as the II and AAII polls go -- while bearish, they're still not as bearish as they were at the March 2009 bottom. This suggests panic could still lead to climactic selling, and another substantial decline.
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