Guest Post: Sentiment Surveys Or Margin Debt Who Is Smarter?

Tyler Durden's picture

From Tony Pallotta of Macro Story

Sentiment Surveys Or Margin Debt Who Is Smarter?

The one and only data point that has given the bears pause is the extremely bearish sentiment readings.  As an example the AAII survey recorded its highest bullish view on December 21, 2010 at 63.3% bullish to 16.4% bearish whereas on June 15, 2011 those readings were 29.0% bullish to 42.8% bearish.

Bulls have argued this contrarian indicator says to buy stocks while bears have scratched their heads questioning why sentiment is so bearish with the VIX below 20 and equities only 7% off their multi year highs. Makes no real sense or does it?

Perhaps the best sentiment reading is the level of margin investors are using to place their bets.  After all, margin means you are literally sitting at the poker table determined to beat the house while the sentiment survey has you sitting behind a keyboard answering questions.  Who is more emotional and thus the one you want to fade?  If you cannot answer this question it is because you are sitting at the poker table as well apparently.

Below is a chart of debit margin balances versus the five week moving average of the AAII bullish sentiment readings.  Notice how bullish views peaked five months before margin levels peaked in 2007. Similarly bullish views peaked in December 2010 (the moving average peaked in February 2011) while margin levels continue to rise through April. Considering the May 1,370 high subsequent margin data when available may very well show May as the peak in margin debt.

There is at least one possible explanation for this divergence. As sellers move out of the market, this historically contrarian indicator entices leveraged longs to increase the use of margin thus supporting prices.  A negative feedback loop is in fact created causing markets to resist selling pressure.

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mynhair's picture

Sentiment, of course.  It's where the money is going to go.


pitz's picture

If you adjust the margin balance by the overall monetary base (ie: M3), or even by the outstanding size of the national debt, margin balances don't look so big.  So I don't see what sort of correlation could be derived from such a chart.

MacroStory's picture

The point is that during the last major market top / economic contraction sentiment diverged the markets as it is today.  Other than the current divergence and that of 2007 sentiment and leverage for the most part correlated whereas now they diverge. Not sure why you would involve the money supply in the equation but regardless the reason of this post was to put some historical context behind this recent divergence rather than the standard bullish view buy the dip because this indicator is contrarian.

pitz's picture

Why involve the money supply?  Because it provides an insight into the magnitude of debt out there.  Obviously $100B of margin debt when the monetary base is 50% smaller is different than $100B of margin debt with the monetary base 100% larger.

Sure, one can make an observation from a chart, but are they really observing a trend, or are they coming up with random conclusions from what may very well be just noise?

The Fonz's picture

This is all moot.  The only place bulls can find energy is in false news or more stimulous. We might get more stimulous, but the market will only be moving up in nominal terms if that is the case.  There has been no will to deal with the consequences from the policitians and there still IS no will to deal with it. 


I read something interesting the other day, it was an assesment of how people percieve the truth when lied to too often. They do not become more able to tell what is real or more  critical... they merely assume everything is a lie.  Since the lies are all bullish for the market then the eventual numbing of the ability of the participants to trust the markets will erode and with it any chance of it going higher. I know that todays news for instance is too overwhelming, I will not leave the market but I cannot believe that it can rise any longer on deceptions.  The deceptions are too pervasive now, and too vulnerable to reality.

Bubbles's picture

Actually M3 money supply contracted between Jan 2010 until about Apr 2011.  BLS stopped measuring M3 but ShadowStats have reconstructed the statistic from available data.  M3 money supply y-o-y change has just turned positive in the last few months.

slow_roast's picture

Algos and Bears: A stock market love story.

IdiotInvestor2's picture

Sounds same to me as - what they do (margin debt) is more important than what they say (survey).

Margin debt is quite high and along with european crisis, lack of QE (till another 15-20% drop) is lighting a fire under the bull's ass. Well deserved IMO.

baby_BLYTHE's picture

when Hyper-Inflation begins in earnest and we start getting into the triple digits

the Printer will say it's just 'transitory'

eureka's picture

I'ld say bottom is hit when 5-10% are bullish. Way further down we go.

falak pema's picture

"Well I guess there's nothing left to say..."

"Why don't you do something, say something...  Goodbye, Ines."

"Where, Where?" 

"Flight N° 8 Tonight for Paris leaves in five minutes gate #3."

"Your name Please?"

"Andre Poulet."

"You won't need this...All right, let's go Pepe."

"Let me out...I didn't want to..."

"Pepe Don't do it."



"See Pepe...". Gives him a last cigarette to smoke.

"The End"

NotApplicable's picture

What value does a market sentiment survey provide in a non-market environment other than to display the awakening of the smart money moving away from it?

As long as previously successful hedge funds keep shutting down I'd say there is no reason to venture where they wont.

rosiescenario's picture

"...previously successful hedge funds keep shutting down..."....probably the very best indicator out there....probably all you need to know.

kgbgirl11's picture

Macro Srory - an interesting juxtaposition, but where do you get your data?! AAII survey hasn't been nearly as bullish as your graph implies for months; current 5 week moving average Is 27.18, about half the value your graph implies. Does your data only go out to March (not very clear from the scale... But if so, it's of little predictive value in June), or how do you get bullish reading that high?

MacroStory's picture

Margin data was only through April so AAII sentiment (where the data is pulled) goes through April as well and to smooth things out I took a five week moving average.  The point with the whole piece is to show that just because sentiment is very bearish right now it was also the case in 2007 and if you bought stocks based on bearish sentiment / contrarian readings you would have in fact been the contrarian.  I find AAII and SPX correlate very well almost real time (week to week) but since January 2011 they have diverged sharply.  I have been trying to understand historically if there was precedence for such a divergence and found it in 2007.  I strongly believe in terms of equity markets we are in December 07 the month the recession started and the month after SPX peaked.  Corporate debt, treasuries, commodities all support this belief as well including the macro data.  My post seems to have caused more confusion than input.  It's not conclusive to say this time you should not fade a historically contrarian indicator but if you can prove it is not always contrarian as I have then as a bear I find more comfort putting less weight on this.  

kgbgirl11's picture

Thanks for clarifying. I happen to share your directional view, that the foundation of the sand castle that's been built post-2008 is being washed away by the waves of reality. I think it's pretty clear that whatever cyclical 'recovery' we may have had needs to be put in the context of a secular bear market. Here is what I wrestle with, however -- how do you present-value a market that's likely to be measured in an increasingly depreciating currency? Most fundamental valuation techniques, as well as technicals actually, imply a stable value of the currency the market is measured in, or at best, extrapolates past inflation trends forward. Shiller 10-year P/E, for instance, adjusts by CPI (which, as we all know, is a heavily underestimated measure of current inflation), however may not be optimal for the world where USD, along with most other fiat currencies, will likely be devalued drastically to cope with debt loads over the upcoming years. And as we know from history, most devaluations are drastically convex (accelerating pace), so doing present-value calcs is a total crapshoot. To what extent will market forces tolerate inflated PV levels as a reflection of future devaluation is what I really struggle with. So my solution is, 1) carry short market exposure in option form 2) buy equities in sectors positively correlated with inflation only for income, at yields that warrant holding it for income (which is very few things these days) 3) hold my 'savings' in PMs with opportunistic positions in PM miners, and short 30yr UST position. Would be interesting to hear your thoughts on how to play the downside.

MacroStory's picture

Regarding how to play the downside, financials have been my favorite sector while this market (until recently) continued to defy gravity.  I've been shorting BAC and WFC through either credit call spreads (one month out and roll or write again) or debit put spreads, sometimes out right long put.  Right now I'm really pressing the BAC short as it sits on the precipice of a waterfall decline if and when the 10.40 level gets taken out. I have really stayed within the financial sector and SPY, nothing else really.  I am long PM miners which truthfully has been painful but I believe in the long term thesis with them. I don't really have a view deflationary or hyper inflation so can't answer your question in terms of putting a value on the market. In the immediate term (3-6 months) I anticipate similar price action to 2007 / 2008.  Should interbank lending tightness accelerate then we could be back into fall 08 mode shortly thereafter.  It's a fluid situation with a deteriorating macro picture so I am trying to be as open as possible to various outcomes.  In the immediate future I would suspect deflation to be the main theme (other than on non discretionary items like food and gas).  Not sure if I'm answering your question or not.  Feel free to contact me through my blog and we can take the conversation off line.

Mec-sick-o's picture

"Margin debt levels, and their rate of change, are sometimes used as an indicator of investor sentiment because margin debt rises when investors feel good about the prospects in the stock markets. In the past, margin debt levels have peaked at the same time market indexes reached relative peaks. When markets decline in a hurry, a large number of margin calls will usually come due, which can add to already heightened selling pressure."

Yen Cross's picture

 Can I smoke A Cuban?