Market Briefs & Sentiment Outlook (MBSO)
Reported by Tony Carrion

http://www.market-harmonics.com

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January, 2012

 January 2012 Market Sentiment Review

To all our readers, a happy and prosperous 2012.  

Despite the daily diet of negative news out of the Eurozone, looking at different corners of the market we find that sentiment is not as bearish as the financial media would have us believe.  Below are some examples.   

According to a recent Bloomberg survey of stock market strategists at 13 brokerage firms, all but one predict the S&P 500 will close higher at the end of 2012.  On average, the group of analysts sees the index rising 6.1% higher than where it closed in 2011.  The most optimistic forecast predicts a 19.1% increase.    

Similar optimism appeared to be shown in the weekly survey of investor sentiment published by the American Association of Individual Investors (AAII) for January 5th, from which we quote below:  

"Bullish sentiment, expectations that stock prices will rise over the next six months, jumped 8.3 percentage points to 48.9%. This is the highest level of optimism since February 10, 2011 (which preceded a market top, Ed). It is also the third time in the past four weeks that bullish sentiment has been above its historical average of 39%."

"Bearish sentiment, expectations that stock prices will fall over the next six months, plunged 13.7 percentage points to 17.2%. This is the lowest level of pessimism since December 23, 2010. It is also more than one standard deviation below the historical average of 30%, making this an unusually low reading. (emphasis added).

Besides being "an unusually low reading," it is also an interesting one, considering the hemorrhage of retail investors out of equity mutual funds that was virtually uninterrupted throughout last year.  The 19% rise in the stock market (as measured by the S&P 500) since last October 4th should likely have something to do with this turnaround in sentiment, not only for retail investors, but for 12 of the 13 Wall Street strategists cited in the Bloomberg survey.

As we have discussed over the past year, one group that has tended to remain more cautious has been money managers.  The above chart plots the average net long/short exposures of money managers from weekly data courtesy of the National Association of Active Investment Managers (NAAIM).  The trough we see in October 2011 was about 59 basis points lower than the previous trough in October 2008.  Net long manager exposures rose to 54% last November, but have moderated since then.  Note that peaks in the ratio have tended to coincide with those in the S&P 500, which makes sense, as money managers become more committed to the long side of the market.  Conversely, lows in the ratio have coincided with stock market lows.  During much of 2011, managers appeared to be either hedging or keeping their powder dry.  Thus, for the predictions of the Wall Street analysts surveyed by Bloomberg to come even close to being fulfilled, this ratio will need to get much higher than it is currently.  That of course assumes a willingness to take on more risk.  How likely is that?

Among the tools we use to study investor risk appetites is the trading trends in the high yield (aka junk) bond market.  As our chart of the iShares iBoxx High Yield Corporate Bond ETF (HYG) indicates, there is decent Elliott Wave evidence to suggest that the Wave 2 rally that emerged off the October 4, 2011 low is either at or near conclusion.  If so, it would be a fairly reliable sign that the "risk-off" trade is returning, and that equities, to which the high yield market is highly correlated, would see some sharp selling return.  At minimum, we are at least alert to that possibility.

Also raising some red flags are the declines in our composite measure of volatility (an averaging of daily VIX and VXN closes) and the 13-day Put/Call Ratio, both of which are at their lowest levels since the late July 2011 stock market peaks.  With the depth of the selling that followed these readings, particularly in August, we also want to be alert to the action unfolding in these two sentiment measures.  

For regular, ongoing commentary on the Elliott Wave trends in all the major markets, be sure to visit our good friends at Elliott Wave International.