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Sentiment is Down But Not Out


Certain indicators are extreme, but not quite to the panic levels we saw at times over the past several years.


I was recently asked for some constructive numbers relative to sentiment during the recent market decline. Well, there actually are quite a few notable extremes among the guides I follow:

  • The four-week average of net bullishness in the American Association of Individual Investors (AAII) has dropped to its 2nd-lowest level since its inception in 1986. The only other comparable time period was August-November 1990 as investors struggled with a looming recession and banking troubles.

  • For two weeks straight, 0 out of 42 Fidelity Select mutual funds had out-performed the return on cash (90-day T-Bills) over the prior quarter. This has happened 10 other times since 1986, with the S&P 500 showing a positive 3-month forward return all 10 times by an average of +7.8%.

  • The smallest of options traders, buying 10 options contracts or less at a time, have finally turned excessively bearish. Last week they spent 24% of their volume buying put options, the most since mid-August. It's not quite at a "panic" reading, though. We'd need to see them spend 25%-30% of their volume on puts to consider it that extreme.

  • Other options gauges are showing similar levels of heightened uncertainty, with the 10-day average of the equity put/call ratio (via the CBOE) showing its 2nd-highest reading in history, behind only immediately after 9/11.

  • Short sales by the public eclipsed short sales by specialists by nearly a 20-to-1 ratio as of earlier this month, a new all-time record. While this ratio has been in a secular uptrend due to the diminishing role of specialists and increased activity of 130/30 funds and their ilk, new records in the ratio have still been relatively effective at highlighting market extremes.

  • Open interest in "smart money" OEX options has tilted heavily toward the call side. This has been a consistent predictor of future market strength.

  • Corporate insiders continue to buy heavily. The InsiderScore and Insider Insights service are showing corporate insider buy/sell ratios near multi-year extremes.

My 2 cents is that many sentiment-related indicators are "extreme", but not quite to the panic levels we saw many times over the past several years, and significantly under the extremes seen during the prior bear market. And as far as I'm concerned, technically we're in a bear market, so I'm not too hip on buying aggressively on "kinda, sorta" sentiment extremes.

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