- - Thursday, September 16, 2010

ANALYSIS/OPINION:

Contrary to most past Septembers, so far September this year has been a boon to the stock market with the S&P 500 up just shy of 7 percent for the month to date. As a result of that strong showing, the index has crossed into the black, up 0.6 percent for 2010 to date. Despite the so-far strong September, the fact that the S&P 500 is barely up for the year is a reminder of how volatile the stock market has been since January and over the past 36 months.

One has to wonder what is driving the strong performance or whether it’s yet another head fake.

One metric to look at in this case is the American Association of Individual Investors (AAII) Sentiment Index Ratio. This is a ratio based on a weekly survey of hundreds of individual investors and it calculates the percentage of respondents who claim to be bullish, bearish or neutral. A reading greater than 70 percent is considered bearish, and a result lower than 30 percent is bullish.

Historically, sentiment readings greater than 70 percent have been timely predictors of corrections in a rising market while readings of less than 30 percent in a weak market indicate a level of fear and capitulation by individual investors which is common at market lows. The logic behind the index is that the public is the last to know what is going on in the market and when the majority of the public is too bullish or bearish it is an indicator that the market is vulnerable to change.

The most recent reading on this weekly indicator suggests to me that individual investors are as confused by the market as institutional investors. Last week’s AAII Bull/Bear Index showed that 50.9 percent of respondents are bullish — a 52-week high. Sounds good, right? But three weeks ago only 20 percent of the survey’s respondents were bullish — a 52-week low. Quite a reversal but let’s remember the nature of the index, a rising sentiment ratio is a negative and while the index is far below the 70 percent level, it’s far closer now than it was only a few weeks ago. A red flag in my view.

What is even more telling to me is the lack of trading volume despite the positive move in the S&P 500, other indexes and the overall market month to date. This suggests to me there is a lot of concern and a lack of conviction in the near term for the direction of the stock market, the economy, the political landscape and more. Fair enough given the political landscape and what may or may not change after Election Day this year.

What I think is driving this lack of conviction is the continued mixed messages we are getting in terms of economic data. As I have said before in this column, it seemed we were one step forward, two steps back in terms of the economic recovery and now it’s one step forward, one step back. For every piece of good news, there seems to be a bad one soon after.

Last week, weekly jobless claims fell more than expected and the week before that we learned that 67,000 private sector jobs were created in August. I know what your thinking on that last part — still way below what we need to keep the unemployment rate flat — but it was still what I would call a lukewarm positive.

This week we hear that U.S. foreclosure activity rose in August from the previous month, and banks and lenders took ownership from homeowners at a record pace, factory activity in the U.S. mid-Atlantic region as reported by the Philadelphia Federal Index contracted for the second straight month in September, a similar report showed manufacturing growth in New York state slowed in September, and a study conducted by Boston College’s Center for Retirement Research found that Americans are $6.6 trillion short of what they need to retire.

Topping off all of that, the Ceridian-UCLA Pulse of Commerce Index (PCI) by UCLA Anderson School of Management fell 1 percent in August, a discouraging figure. The decline indicates an economy that is struggling to move forward, following July’s increase of 1.7 percent and June’s drop of 1.9 percent. It should be pointed out that the August PCI is consistent with third quarter gross domestic product (GDP) growth of 1.5 to 2.5 percent, which is the current consensus view of the economy.

Already, others economists are adjusting their views on the current quarter. Nouriel Roubini has already voiced his view that third quarter GDP will “very likely be below 1 percent” and he now sees the risk of a double dip recession greater than 40 percent.

Rereading the last few paragraphs, it’s not hard to see why so many investors have been staying on the sidelines waiting for signs of a definitive move in the market. That puts upcoming data in the spotlight and data a plenty we will have in the second half of September. Housing starts, building permits, existing home sales, leading indicators, durable good orders, new home sales and consumer confidence are on the docket.

September has been solid in the first half of the month where the stock market is concerned, but let’s remember the months of January and June of this year. Both started off strong in the first half of their respective months only to fall apart in the second half and give back more than the gains they had made.

My thought is better safe than sorry when conviction is low.

Story Continues →