SENTIMENT UPDATE – INVESTORS ARE COMPLACENT
Earlier this week we mentioned the sharp change in short interest over the prior months. I wrote:
Much of the fuel for the 50% rally in the S&P 500 has come from short covering. The general skepticism surrounding the recovery has actually resulted in price gains. But as the rally gets long in the tooth we could be seeing signs that short covering will have a much smaller impact.
The huge declines in short interest are a sign of capitulation in short selling. The bears have been truly slaughtered during this bull run. The change in short interest should be viewed as a contrarian indicator at this juncture. This is also a clear sign of a major change in investor sentiment.
In addition to major changes in short interest, this weeks AAII poll displayed a remarkably bullish reading of 51%. We haven’t seen a reading this high since May 2008 just after the government intervened in Bear Stearns and the market rallied. At the time, everyone was bullish and was declaring that a recession was off the table and a second half recovery was a near certainty. Of course, when everyone is on the same side of the boat, it’s wise to either move to the other side or simply jump off. The bullish side of the trade, in terms of sentiment is incredibly crowded. Positive sentiment can remain high for extended periods of time and can be a major driver in higher prices, however, these environments make for very poor risk/reward scenarios. If any element of doubt or uncertainty creeps into the market we could easily see a sharp and dramatic correction.
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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12 Comments
Do you have updated numbers on the change in short interest?
Thanks
Eric,
This might help:
http://www.reuters.com/article/fundsFundsNews/idUSN1154229920090811
NYSE won’t release the latest data until Monday I believe.
Thanks for the info…it sure as hell is tough being short BAC right now. I think time will prove me right on this one, but it was sure tough when they started walking it up today with the DOW down triple digits.
Yeah, be careful with that one. I dipped my toe in the water on the short side with some of the homebuilders today, but I wouldn’t go near the banks on the short side just yet….Good luck with BAC.
The often stated rationale for shorting are: deteriorating fundamentals, potentially strong positive (price declining) feedback from fear of loss. Banks have the first, but not the latter (ditto TPC’s comment on sanguine/overconfident investors). As well, a strong counter to the latter is potential intervention by the government: buyer of last resort (to a point), lots of creative ability to modify “capital” via reg changes, recapitalization, debt/liability swaps. Banks are also a big component of the indices and there are probably some financial players and insurance companies that sold long-dated derivatives that have a motivated interest in minimizing their liability. No one cares about homebuilders; who else are they going to lay off.
TPC,
What do you think of TYP?
Some comments about BAC by Doug Kass…
http://www.thestreet.com/author/1358076/DougKass/all.html
Van,
I don’t mess with the 3X funds. I tried trading them for a few days and couldn’t make sense of their movements….Plus, risk management is nearly impossible with something so volatile. Sorry. All in all though, tech is not at the top of my short list. In fact, it’s at the very bottom.
Mark Hurlburt’s comment on the short interest below; my question for the professors is what constitutes ‘reltively high short interest’? Also note his comments on other sentiment indicators on 24 Jul. The AAII and II are good enough for me, especially considering Prechter’s comment on traders being 87% bullish after being only 3% bullish in early March.
http://www.marketwatch.com/story/drop-in-short-interest-might-not-be-bearish-2009-08-14?siteid=
TPC,
Thanks. I’ve contributed to the 3X tading gods with FAZ. Luckly i kept it under the single Ks
I’ve made my contributions at the well also.
shorting the banks?
they have a Fed Put, more powerful than the Greenspan put
each and every bank that is failing and being seized by the FDIC has miracously gone instantly bad….wasn’t their Tier 1 just dandy days before….
many of them were not on the FDIC problem bank list
how can this be missed
many were touted as “fine”
how can this be missed
the big abnks are “fine” but bank failures have not abated
there is something fishy