Sunday, May 3, 2009

Investor Sentiment: So Far Not Different This Time

There really hasn't been any change in investor sentiment, but this is not unusual at market tops, which tend to be more drawn out affairs as the discourse between bulls and bears takes on a deafening pitch.  

The bulls believe the worst is behind us as stabilization in the economy will lead to growth and profits.  Being the all knowing and all seeing amorphous beast that it is, the market's meteoric rise over the past 2 months can only mean one thing: there are better times ahead.  We investors - of normal ability and who hail from Main Street - just don't see it. The markets always turn ahead of the economy, and this time is no different.  (Editor's note: this is another piece of Wall Street dogma.)   

The bears would argue that this is just a another bear market rally based upon hope.  The economy remains on shaky ground, and the only thing that has changed is that the economic picture is "less bad" than a couple of months ago.  The technical picture (i.e., market breadth or internals) is more consistent with a bear market rally.

Several weeks down the road, I am sure we will have our answer, and the truth -if it really matters at all- will likely lie somewhere in between.  With so many voices out there, sometimes it is hard to know what we should believe.  

And this is the nature of market tops.  The bear market top of 2008 was a year in the making.  March, 2007 was the first bearish salvo.  January, 2008 was the confirmation that the bear market had begun, and May, 2008 saw a retest of the January, 2008 breakdown.  This was a bull - bear discourse of epic proportion that lead to a massive deleveraging and a breathtaking fall in asset prices.

But I digress....

I think this intermediate term top will take its time to develop, and eventually unravel in the discourse of "where do we go from here?".  Yes, the economy has stabilized but the risk for the bulls is this: "where do we go from here?"  

The burden of proof is with the bulls.  History is with the bears.  And so far it is not different this time.  This is now the 7th week in a row where investor sentiment, as measured by the "Dumb Money" indicator, remains neutral. When we couple this with the fact that prices on the major stock indices remain below their 40 week moving averages, there is a high likelihood that the market will rollover in the next several weeks.  When I first made this observation 2 weeks ago (see "Investor Sentiment: Time To Sell Strength And Tighten Up Stops"), the S&P500 closed the week at 869.60; this past week the S&P500 closed at 877.52.  Hey, a 1% gain over the past 2 weeks works out to a 26% gain annualized and this is nothing to sneeze at.  But it pails in comparison to the 20% plus gain over the prior 6 week period. The NASDAQ 100 is up almost 3% and it is sitting above its 40 week moving average.  This is still within the context of a bear market rally, and I don't see anything different to suggest that it is different this time. 

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.

Figure1. "Dumb Money"/ weekly

The "Smart Money" indicator is shown 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. 

Figure 2. "Smart Money"/ weekly


jonathan smith said...

Makes sense to me. You might check out our work on bearish sentiment and investor pain

Guy M. Lerner said...

Hi Jonathan:

I did look at your investor pain index and the AAII data. I think we have come to same conclusion at least in the intermediate term.

Two caveats on my part: 1) I worry when something makes sense in the market because very few things in the market make sense until they do but what else do we have to go on? 2) with any data that I use always try to figure where I will be wrong; almost any data point that I have used (sentiment, breadth for example) almost always fails at key turning in, what used to be, no longer is. I don't think we are seeing that here, but I am open to the possibility

biscosc said...

Hi Guy,

What will make you change your mind and decide this is something more than a bear market rally? Personally, I agree with you that it is a bear market rally but I know I will have a hard time changing my mind when it comes time to do so.

Guy M. Lerner said...


Great question!

Technically, I have looked for either some sort of launching pad (price consolidation) or the "next big thing" indicator to cycle into position to identify the potential for a secular; we have not seen that with the major stock indices with the exception of the Russell 2000 (which happened at the end of March); I have pointed over several sectors and stocks that meet these criteria and they have performed well. With regards to the major indices, we are close to these things (the potential for secular trend change) happening but they haven't happened; I can identify almost every significant market bottom in the Dow going back to 1925 with this.

Once the potential is there, I will look for some sort of technical marker to get me into the market; either a break of a trend line formed by two pivots or a close above a pivot low point; this is very reliable. Or a close over the 10 month simple moving average. Once again, the sectors that I have highlighted in prior commentaries have these characteristics. Go back and look at the charts carefully. I am pretty consistent in what I do and how I apply it.

So here we are and all I see is a very "V" shaped bounce; there has been no potential for a secular trend change according to my indicators and because of the "v" shaped bounce and because of the way the market action unfold since Oct, 2007, there are no pivot points around on the monthly charts to tag an entry signal to.

Ok, now to your question. In the absence of my signals happening, I am very familiar with research and models that look at buying the SP500 on monthly closes over the 10 month simple MA; such a strategy will beat buy and hold with about 1/2 the draw down. So this is where I would jump in.

So by my measures (pivot points, "next big thing", etc.), we are still in a bear market.

The tools that I am using to make this market analysis are the same tools that I applied to the bond market and Treasury yields, McDonald's, the six sectors with the most potential for a secular trend change, etc. So I aware of the "pitfalls" of my indicators, but I am still not sure that it will be different this time.

biscosc said...

Interesting.. Thanks for the response. I'm curious about the 10-month SMA study. I've done backtesting on daily closes above the 200-day SMA and that didn't appear to have any edge over buy and hold. I think adding another filter to only buying on closes on the first of the month above the 200-day SMA should cut down on the whipsaws. Thanks for the idea.

Guy M. Lerner said...


Credit for the timing model should go to Mebane Faber; I am very familiar with the idea and it has investing merit; you can go to his website/ blog and access the research paper at the following link: