Investor Sentiment: Close But No Cigar

The "dumb money" still appears to be holding out hope that the "test" of the November, 2008 lows will pay dividends. Despite the weak price action, these investors are not bearish to any great degree. In fact for the 13th week in a row, the "dumb money" remains neutral and on the wrong side of the trend.

The "Dumb Money" indicator is shown in figure 1. The "dumb money" looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investor Intelligence; 2) Market Vane; 3) American Association of Individual Investors; and 4) the put call ratio.

Figure 1. "Dumb Money"


As you can see in the figure, the "dumb money" is close to being bearish, and this would be a bullish signal. But they are not quite there yet, and while we can always quibble over a "near miss", the rest of the sentiment picture still is not supportive of higher prices.

For example, see the "Smart Money" indicator in figure 2. The "smart money" indicator is a composite of the following data: 1) public to specialist short ratio; 2) specialist short to total short ratio; 3) SP100 option traders. The "smart money" indicator has had one moderately bullish reading over the past 20 weeks.

Figure 2. "Smart Money"

Other sentiment data, like the Rydex asset data, is not supportive of higher prices either. I discussed the "pitfalls" of the Rydex data in this article, and present an oscillator version of leveraged bulls v. the leveraged bears asset data in figure 3, a weekly chart of the S&P500. This indicator still has a ways to go before a buy signal would be in effect.

Figure 3. Rydex Asset Data/ Leveraged Bulls v. Leveraged Bears

The last piece of data comes from Insider Score, a service that monitors and scores corporate insider buying and selling. I can report that their "entire market" assessment is neutral. At the index level, companies in the S&P500 show a modest level (1 standard deviation) of buying; insiders at NASDAQ and Russell 2000 companies are not buying to any great degree and in aggregate, they remain neutral on the markets.

In sum, the "dumb money" is close to being bearish (i.e., a bull signal), but they are still neutral. It is "close but no cigar". The "smart money" and company insiders have yet to turn bullish. More bulls need to be converted to bears, and this should be confirmed by the "smart money" turning more bullish. I have been saying this for months: lower prices are the only way for the "dumb money" to throw in the towel and the "smart money" to become more bullish. It would be this kind of environment that generates the highest likelihood of a market bottom leading to a contra-trend, tradeable rally.

McDonald's: McRoyal Flush

This is from the Department of Better Tools.

McDonald's Corporation (symbol: MCD) is down 3.5% today on no corporate news. Well, the only news is Cramer calling this a buying opportunity, but isn't that what we have come to expect from our so called "experts"?

In any case and for the record, I made the sell call on January 16, 2009 when MCD was at $58. MCD is down below $53 today.

For those looking for a fundamental bent, strength in the US Dollar and poor economic growth overseas should continue to keep pressure on MCD.

Based upon the technicals, I believe MCD has put in a top of significance, and for long only investors, it is "dead money". A weekly chart is shown in figure 1, and in all likelihood, prices will bounce from these support levels, but I still believe a $45 price target is reasonable.

Figure 1. MCD/ weekly

Dow Transports: Slippery Slope Or Ray Of Hope?

Figure 1 is a weekly chart of the Dow Jones Transportation Index, and the heavy red dots indicate key pivot points, which represent the most important areas of support or buying interest. When support doesn't hold, selling gives way and it is often accelerated. This is a pattern with significance in that back testing shows that breaks below these key pivot points leads to accelerated selling.

Figure 1. Dow Jones Transport/ weekly

This was the pattern that allowed me to write these words about the Dow Jones Industrials on January 20, 2009: "when you connect these pivot points with the maroon colored trend line, you see the result-- a trend line break. This is bearish. Period! Historically, trend line breaks of such pivot points have implied increasing risk as prices can accelerate lower. "

Another pattern with significance is when prices break below a trend line formed by two consecutive, lower key pivot points. Typically, prices head lower as they literally fall out of the channel. And this is what we are seeing with the Dow Transports now. They are on that "slippery slope".

But there is hope - and why not, this is Wall Street. There is always hope.

As seen with the breakdown with the oval on it, this was quickly reversed and prices shot higher. The break down became a fake out. Therefore, a close outside the trend line and then back above will likely lead to higher prices.

This pattern was also seen at the 2001 and 2003 lows. See figure 2.

Figure 2. Dow Jones Transport/ weekly

So let's summarize. The Dow Jones Transportation Index is on that "slippery slope" to lower prices. A reversal back above the break down point would be significant and likely bring higher prices. It appears that a weekly close above 2750 would be required.

Lamenting Gold

My lament on gold has been well documented, and for the entire move from $700 to $1000, I have been on the sidelines unwilling to commit capital.

My reasons for the cautiousness on gold are as follows:

1) Gold would underperform because the US Dollar Index is outperforming. I discussed this in my February 17, 2009 article, "US Dollar Index: Still Bullish". With gold's recent down draft, the US Dollar still has been the better performer over the past 6 months.

2) The long term technical considerations for gold are not bullish; however, they are not bearish either. I discussed this in the January 25, 2009 article, "Gold: Let's Try This Again". In my opinion, gold needed more time before a multi-month secular move could develop. Then, as now, I view gold as range bound.

3) My last reason had to do with gold's performance relative to a basket of 8 currencies. The currencies that I am looking at are: 1) Australian Dollar; 2) Canadian Dollar; 3) Swiss Franc; 4) Eurodollar; 5) British Pound; 6) Singaporean Dollar; 7) Japanese Yen; 8) US Dollar. The indicator, which should lead the price action, has been lagging, and that is still the case today.

A weekly chart of gold is shown in figure 1 with our indicator in the lower panel. The indicator is calculated by determining the price of gold in 8 currencies. I then calculate a 52 week rate of change of each data series, and combine these values into a single, composite indicator.

Figure 1. Gold/ weekly

Despite the recent rise, gold really has been underperforming relative to our 8 currencies. In fact, the indicator is negatively diverging from price, and this, in and of itself, would make me cautious. Most recent price appreciations (labeled 1 and 2 in the graph) saw the indicator leading the price action. On the recent surge in the price action, the indicator has not broken out yet.

My expectation is for gold to remain in a price range with $900 being the first buying point of interest.

Lastly, let's return to my lament on gold. I cannot tell if my analysis is good analysis or just the old adage of a "broke clock is right at least twice a day". Either way, I will stick to my guns and stay on the sideline waiting for my set up.

Watching EWJ

Country specific ETF's have been crushed this year, and like the US equity markets, investors are wondering where is the bottom. Japan has been no exception, and the i-Shares MSCI Japan Index Fund (symbol:EWJ) has lost over 50% of its value in the last 15 months.

To visually see the carnage, check out figure 1, a monthly graph of EWJ. The "next big thing" indicator, which seeks to identify the potential for secular changes, is shown in the bottom panel.

Figure 1. EWJ/ monthly

EWJ should be watched closely for the following reasons: 1) the "next big thing" indicator is close to the zone that has signaled past bottoms; 2) EWJ is approaching its all time lows, and for those investors looking to "catch a falling knife" in a market plunge, this might be a good place to put a buy order in; and 3) EWJ is only modestly correlated with US stocks.

Lastly, I will caution that the "next big thing" indicator only identifies the potential for a secular trend change. Therefore, EWJ goes on my watch list, and then I use more traditional technical analysis (i.e., moving average crossover) to enter and exit the market.

Key Price Levels: February 23, 2009

From the January 20, 2009 "Key Price Levels" I wrote the following about the Dow Jones Industrial ETF proxy, the Diamond Trusts (symbol: DIA): "when you connect these pivot points with the maroon colored trend line, you see the result-- a trend line break. This is bearish. Period! Historically, trend line breaks of such pivot points have implied increasing risk as prices can accelerate lower. " Since that time 24 trading days ago, the DIA is down about 12%. That's 0.5% loss on average per trading day - I would call that an acceleration of prices lower.

Before turning to a chart of the SPY (S&P500 proxy), please review the methodology and the significance of the key price levels by clicking on this link.

My interpretation of the SPY (S&P500 proxy) chart (see figure 1) is as follows: prices never could clear our resistance level at 86.78; this had remain resistance for weeks. The weekly close below the support levels at 82.61 and 81.17 implied increasing risk and an acceleration of prices lower, and the fact that prices are out of the trend channel could really accentuate this dynamic (personal observations). The low from October, 2002 -not a misprint- is at 76.72. Will the market remember these levels? As the price action seems to be unfolding like the DIA in mid-January, the November, 2008 low (74.34) is beckoning.

Figure 1. SPY/ weekly

Figure 2 is a weekly chart of the Dow Jones Industrial ETF proxy, the Diamond Trusts (symbol: DIA). This nicely illustrates my point as the DIA falls out of its trend channel. The October, 2002 low is at 71.81.

Figure 2. DIA/ weekly

Figure 3 is a weekly chart of the Power Shares QQQQ Trust (symbol: QQQQ). This is our "best" performer on a relative basis of course, and the breakout from several weeks ago turned into a fake out, and prices are now back in the channel. The lows at 27.63 are a likely target.

Figure 3. QQQQ/ weekly

Figure 4 is a weekly chart of the i-Shares Russell 2000 Index (symbol: IWM). IWM is still within it's trend channel and holding (on a weekly closing basis) above the significant support level at 40.73. A weekly close below this key level is another ominous sign.

Figure 4. IWM/ weekly

Investor Sentiment: Same Story, Different Week

For the 12th week in a row the "dumb money" indicator remains neutral on the markets, and the "smart money" indicator has had one moderately bullish reading over the past 19 weeks. Like the endless parade of Sunday night bailouts and "breaking news" stories, it is the same old, tired story that is not getting the market anywhere. The S&P500 is down 9% in the last 10 days and almost 14% year to date, yet these measures of investor sentiment still have not materially changed. Over this time period, I have contended that higher prices are not likely unless the "dumb money" becomes more bearish and the "smart money" gets more bullish, and the only way to accomplish this is for prices to continue lower.

Figure 1, a weekly chart of the S&P500, is the "Dumb Money" indicator. The "dumb money" looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investor Intelligence; 2) Market Vane; 3) American Association of Individual Investors; and 4) the put call ratio.

Figure 1. "Dumb Money" Indicator

The "smart money" indicator is a composite of the following data: 1) public to specialist short ratio; 2) specialist short to total short ratio; 3) SP100 option traders. See figure 2.

Figure 2. "Smart Money" Indicator

A 9% drop in the S&P500 over the last 10 days qualifies as "very oversold", and with this in mind, there is a high likelihood of a "bounce" especially since prices are testing their November, 2008 lows. The bulls are counting on it. Nonetheless, the sentiment data suggests that there are still too many bulls on the wrong side of the trend for any meaningful bottom and sustainable rally to develop.

10 Year Treasury Bond: Likely Top

Figure 1 is a monthly chart of the 10 year Treasury bond dating back to the beginning of the bond bull market in 1982. The red price bars denote negative divergences between price and a momentum oscillator. Negative divergences suggest slowing upside momentum, and a cluster of negative divergences over time generally denotes a market top of significance. These clusters of negative divergences are noted within the gray ovals. While there are only five occurrences on the chart, it should be noted that this is a pattern that is repeated in other asset classes over the past 50 years.

Figure 1. 10 year Treasury bond/ monthly


In all likelihood, the upside for Treasury bonds is limited, and there is a high degree of certainty that a new secular trend is developing that favors higher yield pressures. However, as discussed in the article, "Maybe The Bond Market Is Right", yields generally do not rise during a recession, and a bet for higher yields (i.e., against bonds) is a bet that the reflationary policies of our government will work. Of course time will tell as to what dynamic wins out. But for now, I believe money in Treasury bonds is dead money.

About My Indicators

I receive a lot of email questions regarding my "smart money" and "dumb money" indicators. In addition, folks also seem to be interested in the "next big thing" indicator, which I use to identify the potential for secular trend changes.

I appreciate the questions about and interest in my work, but at this time, I am not willing to share all the details on how these indicators are derived. The indicators are proprietary, and I would like to keep them that way for now.

While some readers may not like that, I can tell you that there is nothing ultra special regarding the indicators. For example, take the "dumb money" indicator, which looks at investor sentiment. The purpose of the indicator is to identify when investors are extreme in their market outlook - as in, investors are either too bearish or too bullish. The importance of such an indicator is obvious as most investors are wrong about the direction of the market, so why not develop a tool that seeks to exploit that knowledge. Determine which way investors are leaning, and go against them.

Like most most indicators that I have explored, my tools are no holy grail. There have been times (2002 and 2008), when the S&P500 had significant draw downs (> 10%) even though the "dumb money" was extremely bearish. In these instances, the indicator failed spectacularly. Remember, I don't have the holy grail here.

But what I do do well and what I believe most people don't do is determine through the back testing process how all these indicators work. Many people don't like back testing because the past doesn't always predict the future, and this is true especially in the markets. But I will always counter with the following: if you don't know what worked in the past, you definitely won't know what works in the future. You need to do the work. It is a learning process.

You need to look at many different market environments (i.e., bull and bear markets), and many different markets. Unfortunately, most analysts and commentators only look to the left of the chart and typically they stop at the left hand edge of the computer screen. I am often reminded of one prominent blogger who "called" a sell signal in gold based upon a MACD cross on a monthly chart. But if you looked at the every other prior MACD cross in gold and in US equities (on a monthly chart), a MACD sell signal was more likely a better buy signal for both gold and US equities. So why even bother with such a tool if it doesn't work? But the only way, to know if it doesn't work is to do the work.

So while I won't share with you the actual formula for my indicators, I will always share with you how these indicators perform. I use the indicators to define a market environment and from this information, we can determine an expected return over a certain period of time. As an example, for the last 3 months I have stated on numerous occasions (every week) that higher prices are unlikely with the "dumb money" being neutral and prices below their 40 week moving. Historically, with this set of conditions, this was the high odds "call".

I really don't think I have done anything special with the "smart money" and "dumb money" indicators. Their premise for their continued use is sound. To beat the market, you cannot be the market. Therefore, a contrary approach, in my opinion is best.

The "next big thing" indicator is interesting if only because of some of the innovations and insights that I have made in constructing the indicator. The indicator is completely technical in nature; there is no fundamental data (i.e., interest rates) in there. Like most of my indicators, it is a composite of several observations, and it works across multiple markets. The "next big thing" indicator is no holy grail, but its usefulness is identifying the potential for a secular trend change in a particular asset. Once an asset has been identified that it might undergo a secular trend change, I then use more "traditional" technical analysis (i.e., moving average crossovers) to enter and exit a market.

What are some of the technical innovations that go into the "next big thing" indicator? For starters, I count (or rather I program the computer to count) the number of positive divergences between price and an oscillator across a certain time period. Typically, a certain number of divergences are seen at major market bottoms as the downward trajectory of prices slows. Another innovation is my use of pivot points. I can count (or rather I program the computer to count) the number of pivot points (high and low ones) from a prior market top. These findings can be quantified for many markets and are fairly consistent. During a bear market, an asset will typically thrust downward and pivot upward a certain number of times before bottoming. This would be akin to the waves that an Elliot Wave technician might discuss.

Once again, I am appreciative of the emails and comments - good and bad. Just remember, there is no holy grail, and while my word should not be end all or be all to your market analysis, I will always do my best to present my data objectively.

US Dollar Index: Still Bullish

My reluctance to embrace the rally in gold has been well documented. One of the reasons, I did not jump on the gold band wagon was the strength in the US Dollar Index. Since August, 2008, it has been my belief that the US Dollar was poised for a secular change in trend and that gold has only been in a range. Based upon this, it remains my belief that the US Dollar is a better place to invest.

As an aside, my premise of the US Dollar being a better investment than gold is not too far off. Since August 31, 2008 gold is up about 15% (with a lot of volatility), and the US Dollar is up about 13% (with a lot less volatility). Seems like six of one half dozen of another kind of thing.

So let's leave gold aside for a moment (as I don't know anything anyway), and let's focus on a monthly chart of the US Dollar Index. See figure 1. The US Dollar Index is up strongly this morning as the green back has become a safe haven during these times of global economic duress. Yet, in this environment of currency devaluation, it just doesn't make sense that the Dollar is higher. Higher gold we can understand; gold is a store of value. But a higher US Dollar?

Figure 1. US Dollar Index/ monthly

Yes! And I think the US Dollar is going even higher. The question becomes: how high?

Historical back testing shows that most moves in the US Dollar end with a negative divergence between price and a momentum oscillator. These negative divergences are noted with the pink markers on the price bars in figure 1. While the most recent price bar is not a negative divergence bar, higher prices will likely lead to a negative divergence over the next 6 months as the oscillator used to define the negative divergence is unlikely to confirm the higher prices.

It is my guess - and only a guess - that the Dollar Index could trade as high as $91.57. Returning to figure 1, this is the next level of resistance as defined by the prior pivot point high and negative divergence bar. Certainly, Dollar weakness has been a much touted event, and maybe at this level (i.e., a double top), the US Dollar Index will falter.

Investor Sentiment: More Bulls

Both the "smart money" and "dumb money" became more bullish in their outlook last week.

This is what one would expect from the "smart money" - lower prices bringing out more bulls. The "smart money" refers to those investors and traders who make their living in the markets. Supposedly they are in the know, and we should follow their every move. The "smart money" indicator is a composite of the following data: 1) public to specialist short ratio; 2) specialist short to total short ratio; 3) SP100 option traders. See figure 1, a weekly chart of the S&P500, for the "Smart Money" indicator, which is only moderately bullish. As the November, 2008 lows are approached, this is the most bullish reading for the "smart money" in 18 weeks.

Figure 1. "Smart Money"

Figure 2, a weekly chart of the S&P500, is the "Dumb Money" indicator. The "dumb money" looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investor Intelligence; 2) Market Vane; 3) American Association of Individual Investors; and 4) the put call ratio.

Figure 2. "Dumb Money"


The "dumb money" is neutral on the markets, and they have been that way for 11 consecutive weeks. Over this time period, I have contended that higher prices were not likely unless sentiment became more bearish. This remains the most likely scenario as we need lower prices to convert more bulls to bears.

As mentioned last week, the NASDAQ 100 bares watching as a the price action in this index remains constructive despite the lackluster sentiment picture. There is precedent (as in 1995), although the evidence is scant, for higher prices that is embraced by the "dumb money". Typically, the "dumb money" is sitting on the side lines when the markets start to move higher.

In the end, the "smart money" is starting to warm up to the idea of lower prices while the "dumb money" remains neutral. From a sentiment perspective, there really is no edge. Last week's dismal showing did bring out more bulls in both camps.

Natural Gas: Put It On Your Radar Screen

Figure 1 is a monthly chart of natural gas (cash data) with the "next big thing" indicator in the lower panel; the "next big thing" indicator quantifies those technical factors typically seen prior to secular trend changes in an asset.

Figure 1. Natural Gas/ monthly

As you can see from this very long term view, natural gas has sold off rather nastily over the past eight months. Prices have found support at a long term trend line. While it is difficult to know for certain that this trend line will "hold", this is the kind of asset that picks my interest - down and out and off every one's radar. The "next big thing" indicator does not suggest a long term secular trend is at hand, but I am willing to wager that natural gas isn't going any lower for a while.

Put natural gas - and equities tied to natural gas- on your radar screen.

Key Price Levels: February 12, 2009

It's another week and the equity markets are doing their best to befuddle investors and traders by moving in a new direction than the previous week. To complicate matters, the major indices are not moving in unison with the Power Shares QQQQ Trust (symbol: QQQQ) showing signs of starting an uptrend. The other major indices clearly remain under pressure, and still represent better selling opportunities.

To review the methodology and the significance of the key price levels please click on this link.

My interpretation of the SPY (S&P500 proxy) chart (see figure 1) is as follows: resistance remains at 86.78, and a trading advance in the SPY will not commence without a definitive close over this level. The lows (81.17) of the range are clearly noted and were tested and held last week. This morning's gap down is retesting support levels (81.17).

Figure 1. SPY/ weekly


Figure 2 is a weekly chart of the Dow Jones Industrial ETF proxy, the Diamond Trusts (symbol: DIA). The DIA remains the "weakest" of the four major indices. A break below the maroon colored trend line should portend weakness and a possible acceleration lower in prices. The lows (80.15) of the trading range were tested and held last week, but the bounce was met with selling this week at old resistance levels (82.64). This morning's gap down is into the bottom of the down trend channel. I would expect a bounce, but the down trend continues with the November, 2008 lows in sight.

Figure 2. DIA/ weekly


Figure 3 is a weekly chart of the Power Shares QQQQ Trust (symbol: QQQQ). The key resistance level of 29.72 was decisively taken out last week; in addition, the QQQQ broke out of its 13 week range by closing above the most recent pivot high. These are bullish developments. Old resistance becomes support, so 29.72 is now support, and we should expect buying here if the bullish price action is to continue. If this scenario plays out bullishly (and this is still a big if in this environment), the QQQQ's could easily make it to $36.

Figure 3. QQQQ/ weekly


Figure 4 is a weekly chart of the i-Shares Russell 2000 Index (symbol: IWM). IWM is no man's land as prices remain in the middle of the channel. A close below 43.64 will lead to a retest of the lows, and a close above 49.23 is a breakout from the range.

Figure 4. IWM/ weekly

The good news for the bulls is the positive price action in the more speculative NASDAQ 100. Th bulls can always point to NASDAQ 100 leadership; it is something they understand and believe in, and like the late 1990's, technology can always light a fire under the rest of the market.

The bad news for the bulls is that the market environment remains treacherous, and it remains pretty much driven by sentiment, which I contend is not supportive of higher prices. Only 1 out 4 of the major indices is looking bullish, but once again, it is everybody's favorite, technology.

The Technical Take: Copper And Shanghai Stock Exchange Composite Index

Figure 1 is a monthly chart of a continuous copper contract. The "next big thing" indicator is in the lower panel; this indicator seeks to identify the potential for secular turning points.

Figure 1. Copper/ monthly

From the July, 2008 highs to the December, 2008 lows, copper dropped over 60% in value. It's fall has mirrored the global financial crisis and economic weakness. Over the last 2 months, copper is about 20% off its lows leaving investors to question whether the bounce is foretelling true economic strength - as in, the global economy is back.

The quick answer is, "No. This is only a bounce."

Copper stopped going down and found support at the old 2005 breakout levels. See point 1 in figure 1. This was a logical place for copper not only to find support (and stop going down) but to bounce as well.

The next big thing indicator is in the middle of its range (point 2, figure 1), and it is certainly not in a position that would indicate that a secular trend change is a likely event in the near future. Copper, like the global economy, will need time to "heal" or consolidate. Why is a period of consolidation important? My interpretation of a period of consolidation suggests that the forces of supply and demand are in balance, and a breakout from this range suggests increasing demand.

But let's think practically what happened to copper over the last 6 months of 2008. Copper lost 60% of its value in 6 months! What other subtle clues do you need to suggest that a secular trend change is currently at hand. In other words, a 6 month drop of this magnitude won't be reversed by 3 months of positive price action.

Figure 2 is a monthly chart of the Shanghai Stock Exchange Composite Index; the "next big thing" indicator is in the lower panel. This index peaked in October, 2007, and it lost over 60% before finding support and bouncing at the 2006 break out level (point 1, figure 2). Since those October, 2008 lows, the Shanghai Index is up 33%. The down sloping 10 month moving average (or approximately 200 day moving average) is only 100 points or 5% away. After the drop we saw this past year, what is the likelihood that prices will keep levitating above this key level? In my experience, this is not a high odds bet.

Figure 2. Shanghai Stock Exchange/ monthly

Lastly, let's take a look at figure 3, which is a monthly chart comparing copper (orange line), crude oil (black line) and the Shanghai Stock Exchange Composite Index (green line). China, which is the global growth story, is closely linked to these commodities; certainly growth in China would be reflected in demand for copper and crude oil, but only copper seems to be moving higher. If global growth is back, why is crude oil lagging?

Figure 3. Shanghai Stock Exchange v. Copper v. Crude Oil/ monthly

If I may steal a word from Trader Mark, who writes the superb blog "Fund My Mutual Fund", it is "thesis". Trader Mark always wonders what is the next "thesis" that traders will pile into for the next 20% gain. The global growth story is a great thesis, but according to the longer term charts, it is not a thesis that will have sustainable legs. That story is for another day a long ways away.

Investor Sentiment: No Edge Provided

Investor sentiment is not providing an edge as the "Smart Money" and "Dumb Money" indicators continue to hold to the neutral ground.

Figure 1 (a weekly chart of the S&P500) shows the "Dumb Money" indicator. The "dumb money" looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investor Intelligence; 2) Market Vane; 3) American Association of Individual Investors; and 4) the put call ratio.

Figure 1. "Dumb Money"

The "dumb money" is neutral on the markets, and they have been that way for 10 consecutive weeks. Over this time period, I have contended that higher prices were not likely unless sentiment became more bearish. There were too many bulls caught on the wrong side of the trend, and more bulls needed to be converted to bears before a multi month, counter trend rally could unfold.

However, a new wrinkle has happened along the way. Last week, the NASDAQ 100 printed its highest close in 14 weeks. In other words, we have higher prices in spite of the neutral sentiment picture, and this situation is rather unusual. Before discussing how unusual this is, let me digress and define for you the price cycle.

The price cycle is the path prices take from low to high and back to low again. Market practitioners have devised many tools to divine these highs and lows, but few of these work with any consistency. I use investor sentiment to define the lows and highs of the price cycle as fear and greed are fairly consistent behaviors at market bottoms and tops, respectively. Exhaustive research has shown that the best, most accelerated market gains occur when the majority of investors are on the sidelines and fearful of further market losses. As the market turns, those on the sidelines pile back into the market chasing performance and propelling prices higher. This is when our price cycle begins. When those same investors are overly bullish and complacent in their outlook, stocks are generally facing headwinds as those already invested are “all in” and there are few investors on the sidelines to keep prices moving higher. At this point, we expect the price cycle to end.

So why digress about the price cycle? The price cycle, which started on November 21, 2008, ended January 9, 2009 because history tells us that after 5 weeks of neutral investor sentiment and lackluster breath we should expect lower prices. And we did get lower prices - i.e., the worst January ever by the Dow Industrials and S&P500.

So what happens when one price cycle ends? In 44 of our 45 signals since 1990, investor sentiment will turn bearish before higher prices are seen. In other words, higher prices are typically preceded by the "Dumb Money" indicator turning bearish, which is a bull signal, and this begins the price cycle anew.

However, let's get back to the NASDAQ 100. We now have higher prices yet we never passed through the "dumb money" investor turning bearish phase. This is our wrinkle.

The prior occurrence of this wrinkle occurring is noteworthy, and this is January, 1995, which is the kick off to the mega bull run of the late 1990's. However, there are some key technical differences from the current time period when compared to 1995. For one, prices in 1995 were coming out of 24 month consolidation and this was a very good launching pad for a monster bull run. Currently, this looks like a "v" shaped bounce, which generally is not sustainable. Secondly, back in 1995, prices were above their 200 day moving average by the time the breakout had occurred. Lastly, the "smart money" was bullish back in 1995. It should be noted that the "Smart Money" indicator has been bearish for 15 consecutive weeks now.

Figure 2 shows is a weekly chart of the NASDAQ Composite with the "Smart Money" indicator. The "smart money" refers to those investors and traders who make their living in the markets. Supposedly they are in the know, and we should follow their every move. The "smart money" indicator is a composite of the following data: 1) public to specialist short ratio; 2) specialist short to total short ratio; 3) SP100 option traders.

Figure 2. "Smart Money"

So this is our conundrum:

1) Higher prices can occur in the absence of the "dumb money" turning bearish, but it is not the norm.

2) The NASDAQ 100 is the only major index showing "strength". The Dow Industrials, S&P500, and Russell 2000 continue to trade to resistance levels, and based upon the current sentiment picture, these indices represent better selling opportunities.

3) The NASDAQ 100 is providing leadership, and proprietary studies show that this is good leadership in that returns in this speculative index can lead to out performance in the S&P500. Anecdotally, investors "believe" in technology as a market leader, and strength in this index could lead to broader market strength.

4) From a technical perspective, this is not 1995.

At present, the sentiment data is not very useful. If it wasn't for the positive price action in the NASDAQ 100, I would say something like, "sell strength" or "the time to get bullish is when everyone is bearish". But I cannot say that as I respect the price action too much. For now, it appears we have a split market with no clear cut edge.