Sunday, July 12, 2009

Investor Sentiment: What's Next?

After being bullish for 9 consecutive weeks and having seen the S&P500 fall some 5% over that time, the "dumb money" has finally given up hope. The "Dumb Money" indicator has moved from a bullish extreme to the neutral zone.

The "Dumb Money" indicator is shown in figure 1. The "Dumb Money" indicator 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/ weekly

Let's compare the past 9 weeks when sentiment was bullish (i.e., bear signal) with the time period from February 27 to March 20, 2009 (4 weeks) when the "dumb money" was bearish (i.e., bull signal). As we know over the last 9 weeks, the S&P500 has lost ground as "green shoots" turned brown. As we remember from the earlier period, the S&P500 gained a little over 4% before lifting off some 25% higher over the next two months. So this is why I watch investor sentiment.

So what's next for investor sentiment? Unless this turns out to be a bull market (and I have expressed my doubts since the start of the rally on March 9), the most likely course is for the "Dumb Money" indicator to cycle into a bearish extreme (i.e., bull signal) over the next couple of months. And there are only two ways to get more bears: 1) we either have a protracted trading range that wears the bulls down; or 2) we have lower prices.

In the short term, there is always hope for the bulls as prices on the S&P500 remain above the down sloping 40 week moving average and above the key support level at 876. In addition, personal research shows that prices will likely move higher in the week or two after the "Dumb Money" indicator has moved from extremely bullish zone (i.e., bear signal) to neutral as it did this past week. Into this this mini - lift would be the optimal time to sell (if you haven't done so already). Of course, a weekly close below the 876 level and the 40 week moving would be an ominous 1-2 punch for the bullish cause, and certainly reason enough to "get out of Dodge!"

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. The "smart money" is neutral.

Figure 2. "Smart Money" Indicator/ weekly

6 comments:

Anonymous said...

good stuff. Barrons reported AAI 55% bearish which is as high as it was since March bottom. Lets see if this high AAII bears numbers indicates the mini left this week or if prices drift lower and bears grow even more.

Guy M. Lerner said...

Anonymous: There is always risk that prices will fall thru the 40 week (200 d ma); but when you back test these things out over the past 20 years the optimal play following a move in the "dumb money" indicator from too bullish (i.e., bear signal) to neutral -like last week - is to wait for higher prices above the 40 week ma; therefore, I stated we might get a lift this week. Prices might just keep crashing thru the 40 wk. ma but this isn't the norm.

Stas said...

One more excellent post! This week may be banks will show good numabers... So, may be 915 is top? :)

Stas said...

And many technicall players think, that we will retest 956 - what you think about it? I think it`s almost impossible without good earnings, or economi indicators, or may be new stimulus packages ( but about it we will think in august IMHO)...

Anonymous said...

Hello Guy M Lerner
Thank you for your blog post's about smart/dumb money.
Have you seen this site
http://icf.som.yale.edu/financial_data/confidence_index/index.shtml
Vito

Guy M. Lerner said...

Vito

Thanks to the excellent link to the Yale Univ data; you just gave me another 6 hours of work!!!

Much appreciated