Sunday, September 20, 2009

Investor Sentiment: It's Odd, But True

Market participants remain all giddy about the bullish developments of the past months. Yet, one year ago, a level of 1200 on the S&P500 had everyone in a panic, and this was before a 20% two week plunge. On Friday, with the SP500 closing at 1068, everyone is now ecstatic and most investors see nothing but blue skies ahead even though the fundamental outlook is just as muddled as 12 months ago. It's odd, but true. Two different investor outlooks but essentially the same level on the S&P500. So what has changed?

Investors' perceptions. It's where we have been (S&P500 ~666), where we have gone (S&P500 ~1068) and how fast we have gotten there (over 6 months) that investors attach significance too. It's not the fundamentals. It's not the values. It's the change in price and the hope that the market is forecasting what most of us cannot see: a robust economic recovery.

I can understand the buying at the March, 2009 lows. There was a dislocation in the markets, investors were bearish (i.e., bull signal) and great values were to be had. This was the time to be bullish. I can understand the buying back in early July, 2009. This was likely due to short covering as traders expecting and positioned for the markets to rollover threw in the towel giving the markets much needed fuel to move higher. And I can even understand the buying now. The markets are in a strong up trend.

But to attach any significance to the market's current strength is wrong. It is just the same old story of fear and greed. The difference between March and now is that the party is getting very crowded, and when the punch bowl is taken away, most investors will have a difficult time finding the exits. Anecdotal evidence would suggest this is particularly so in a market driven by notions of "liquidity"; sell offs can be rather brisk.

None of this is to suggest that I see a sell off in the near future, but from this perspective, risk is rising. As I have been stating for several months now, there is an upward bias until the extremes in bullish sentiment are unwound. Shorting the major indices beyond 1 hour seems to be a difficult notion in this market.

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. The "dumb money" remains extremely bullish.

Figure 1. "Dumb Money" Indicator/ 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. The "smart money" is neutral.

Figure 2. "Smart Money" Indicator/ weekly

Company insiders have resumed selling of their shares to an extreme degree. See figure 3, a weekly chart of the S&P500 with the Insider Score "entire market" value in the lower panel.

Figure 3. InsiderScore Entire Market/ weekly

Figure 4 is a daily chart of the S&P500 with the amount of assets in the Rydex bullish and leveraged funds versus the amount of assets in the leveraged and bearish funds. Not only do we get to see what direction these market timers think the market will go, but we also get to see how much conviction (i.e., leverage) they have in their beliefs. Typically, we want to bet against the Rydex market timer even though they only represent a small sample of the overall market. As of Friday's close, the assets in the bullish and leveraged funds were greater than the bearish and leveraged; referring to figure 4, this would put the green line greater than red line.

Figure 4. Rydex Bullish and Leveraged v. Bearish and Leveraged/ daily


DavidDT said...
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DavidDT said...
speaking of market rising to prior levels - that is true, but worth nothing that ROC was not up to the par with decline speed. Fibonacci Arcs (circles) demonstrate that market move up lagging (blue arrows).
In spite of common view that we are in the bull market and out of the bushes SPX is still in confines of downtrending channel (yellow) and it is really a huge surprise that after massive de-leveraging attributed volatility (green ) market is able to move up at all.
Only FED supplied liquidity keeps it alive, that and debasing of currency. But it came as no surprise, on July 9th SPX target was defined as 1120 and we are so close - have a gut feel that a lot of things will change next week.
What amuses me is that long portfolio opened on March 2nd
was up almost 125% by July, but it is only up another 30% in the same period of time afte rthat.
"Common sense is not so common"

Guy M. Lerner said...

Hi DavidDT

Thanks for the input

For the past several weeks I have been mulling around in my head an article entitled "Mission Accomplished". There are gaps over head that represent the breakdown last October and that would be a good place for the market to reverse. We are also seeing a victory lap by the President here; it's not an overt one but he wouldn't be on the TV shows today and Letterman tomorrow nite if the stock market was still in the toilet; if you don't have a job, which is a lot of people, then things aren't good either; or if you are under water in your home (25% of us) and your future probably looks somewhat bleak as well as you are stuck. But that is a different matter because all that matters is the stock market is up -things have to be better.

The James Grant article in the WSJ suggested the Fed liquidity was about 7x stronger than previous recessions and since the Fed missed the recession they are determined not to mess up the recovery --ie., foot on the pedal.

This still makes the Dollar the key asset to watch; commodities will be likely out performers and stocks will do fine but suffer from the occasional downdraft because of inflation and valuation concerns (real or percieved); bonds will trail; this seems like I have seen this movie before (i.e., 2003 to 2007).

This is how I see things over time but within these parameters, there will be cycles between fear and greed

With regards to your portfolio that you referenced, it is well known that the best -most accelerated gains- are behind us, and I think that is what that shows.

Anonymous said...

How much credibility do insiders have? When we look at the AAII investor sentiment or Dow Jones Investor sentiment data, we are looking for extremes to indicate when we should do the opposite. Are insiders so good that we should follow them, or do we bet against them too?

Guy M. Lerner said...


How much credibility do insiders have? I use InsiderScore which has data going back to 2003; for the most part their entire market score tracks the dumb money indicator very well; but the utility in their service is that they provide insider buying and selling at the sector level -which is cool.

It should be noted that financial insiders were buying at the highs in Oct 2007 so they were drinking the kool aid too; insider selling and buying is better at finding bottoms than tops