Investor Sentiment: Converting Bears To Bulls

As the equity markets continued their surge this past week, more bears have been converted to bulls. The number of bulls is by no means extreme, but as key resistance levels are approached, it appears that there will be fewer investors on the sidelines (i.e., new buyers) that could possibly power the market higher.

The "Dumb Money" indicator is shown in figure 1, and it is in the neutral zone. 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"/ weekly

This is the third week in a row where the "dumb money" is neutral. If the indicator remains neutral for 4 - 5 weeks while prices remain under their 40 week moving average, then there is a high likelihood that the market will rollover. I discussed these observations in the article, "Investor Sentiment: Some Context".

Last week I stated: "...I think it is very likely that lower prices should bring out the dip buyers and those still on the sidelines looking to get long because they missed their opportunity three weeks ago." If the rally pushes on in the coming weeks, there will be fewer and fewer buyers and investors on the sidelines as more bears are converted to bulls. Unfortunately, for these latecomers, key resistance levels would be hit as the number of bulls becomes extreme.

Figure 2 is a weekly chart of the S&P500, and we can see that 876 is that key resistance level.

Figure 2. S&P500/ weekly

Since this rally started 4 weeks ago, I have always contended that this was a contra trend rally within an ongoing bear market. I still don't see any technical evidence to change my opinion. This continues to be a bear market rally. Therefore, it is my expectation that we will be selling strength in a several weeks as momentum wanes and resistance levels are hit.

For completeness sake, I have included the "Smart Money" indicator in figure 3. 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 3. "Smart Money"/ weekly

The "smart money" remains neutral and this is surprising considering the 20 plus percent run in the major indices over the past 4 weeks. I would expect the indicator to turn down over the next couple of weeks (i.e., become less bullish) as prices approach key resistance levels.