Sentiment Update – Investors Swing Back To The Bear Side

We carefully monitor what investors are thinking and doing. This provides insight into what they feel about the market, which is important because over 50% of a stock’s price move is driven by emotion.

With the price decline over the last three weeks, market sentiment has rapidly switched from bullish to bearish. We are particularly struck by the size of this swing, as you’ll see. A large, rapid shift to bearish sentiment after an extended advance is usually the sign of a short term correction.

The Short-Term Master Sentiment Indicator

By integrating several different sentiment indicators into one, we have created two master sentiment indicators. The chart below is the short-term master sentiment indicator, and it measures what investors expect for the short to intermediate term.

What’s striking about this chart is how small the price correction’s been – shown by the green circle – and how large the indicator has swung toward the bearish side.

During an advancing market you don’t expect sentiment to move into the Green Zone during corrections. That happens during bear markets. You expect it to move about halfway like the current situation. We’ve indicated with two green arrows, past moments when this happened.

This current three-week decline has all the earmarks of being a short-term correction.

The Long-Term Master Sentiment Indicator

The next chart is the long-term Master Sentiment Indicator. The MSI is made from a combination of nine indicators. We use it to help determine whether investor sentiment supports a bull or bear market.

The chart shows last year’s strong, “green zone” buy signals. As the rally progressed off the October lows, sentiment slowly shifted and the MSI moved from the Green Zone towards the red.

We don’t think the red zone reading a few weeks ago signaled the end of the bull market and/or the beginning of a major correction – at least not yet. So, there’s nothing in the current MSI that indicates to us that the recent three week decline is anything but a short term correction.

Investor Surveys and Opinions

Our master sentiment indicators include five surveys that measure the thoughts and opinions of investors and advisors. The table below positions these surveys on the Sentiment King bull-bear ranking scale. As you can see all five surveys are currently on the bullish side of the neutral zone, so are not signaling anything significant at this time. They’re explained in the text below.

NAAIM Exposure Index: The average investment position of the American Association of Active Investment Managers (NAAIM) is 59%, with its four week moving average at +2.5 on our scale. This is a neutral reading from Active Money Managers.

Hulbert Survey: Our ranking of the Hulbert survey of newsletter writers for the general stock market, and the Nasdaq in particular, show rankings of +6 and +2, respectively. Both are on the bullish side of neutral.

AAII Member Sentiment Survey: Just 36% of AAII members were bullish last week, while 32% percent were bearish. The Sentiment King ranking of this survey is +4, which is the bullish side of neutral

Investors Intelligence Newsletter Survey: Last week, 36% were bullish, 30% bearish and 34% expecting a correction. This survey has a history back to 1963, and our ranking of this famous sentiment indicator is currently +6, which puts it three levels away from the extremely bullish red zone.

Summary of the Opinions and Surveys: The overall score for all five surveys is now +4, as shown by the yellow X. This relatively neutral reading allows for a continuation of the October rally once this short term correction is over.

What Buying and Selling Indicators Are Saying

We monitor six indicators that measure what investors are buying and selling. They’re shown in the table below.

S&P 500 E-mini COT – This indicator receives a +7 rating due to asset managers’ modest short positions in E-mini S&P futures. This is one step from a red zone reading.

ProShares Short S&P 500 fund (SH): Investor purchases of this short fund continue to be historically strong, amounting to a daily average of 16% of assets per day. Two weeks ago it was 12%. This large investor interest in shorting the market is near the green zone and a strong indicator for higher prices.

“Puts to Calls” Ratio: The ratio of equity “puts to calls” is now in the green zone, giving the market a strong buy signal. The ratio of total “puts to calls”, with a ranking of -7, is nearing the green zone. These are bullish for the market.

ProShares Bear/Bull Ratios: We have two indicators that measure how much investors are buying ProShares short funds compared to long funds. One, which measures all their funds, went from +3 to -1 on the ranking scale. The other, which measures only the ProShares UltraPro funds, went from zero to -3.

Summary of Buying and Selling Indicators – The overall score for all six investor activity sentiment indicators is -3, which is the bearish side of neutral.

Indicator Focus

We focus on one sentiment indicator every update. This one graphs buying in the ProShares short fund, SH, as a percent of assets.

This indicator shows there is still too much interest in this short fund to signal any major top of the market. In fact the increase of buying to 16% of assets from 10%, shown by the black circle, is an additional sign this three week price decline is short term and not the start of a major move.

History shows one should get concerned only when buying declines to just 5% of assets.

Conclusion

As both Master Sentiment Indicators show, there has been a strong movement toward bearish sentiment over the last three weeks. The Short Term-Master Sentiment Indicator shows the strongest and clearest switch. It’s a sign of “jumpy” investors and of the investor “wall of worry” that always accompanies higher prices. To us, it means this decline is a short term correction and a sign the stock market is about to move higher.