Saturday, December 12, 2009

Investor Sentiment: Stagnation

Like the markets, the sentiment indicators are in a state of stagnation. For 3 months now, investors continue to be overly bullish, insiders continue to sell, and the smart money remains indifferent. Not surprisingly over this time, the S&P500 has been stuck in a range too.

A breakout and a move higher from this price range would likely be a blow off leading to a market top. This remains the outlier. The more likely scenario is for sentiment to cycle from the current too bullish to a more bearish posture, and the best way for this to occur is to have lower prices.

For those who follow investor sentiment, the past 6 months have been one of those rare moments when there were too many bulls and prices still continued meaningfully higher. This is the scenario that I called "it takes bulls to make a bull market". It can be frustrating, and it has given the appearance that following investor sentiment this past year has been a failure. Maybe so. However, sentiment was appropriately bearish (i.e., bull signal) at the March lows, and as I have been stating for the past 3 months, my expectation has been for a trading range. And this is what we got!

But going forward and that is what counts, I expect the sentiment indicators to work with more pinpoint precision -if such a thing actually exists in the markets - like they have in the past. Why this should be is two fold: 1) indicators or trading systems usually go through periods of under performance which are followed by periods of out performance, and the sentiment indicators probably are no different although the uniqueness of these tools to align oneself against the consensus is powerful and generally effective; 2) fear and greed have not disappeared from the markets.

One last comment is in order, and this concerns last week's comments on the Dollar. The down trend in the Dollar is done for now. Equities, which held up this past week despite the rise in the greenback, would seem to be at risk as the "anything but the Dollar trade" goes out of vogue. One day or one week doesn't make a trend, but I am skeptical that a higher Dollar will all of sudden turn out to be a new tonic for the equity markets.

The "Dumb Money" indicator, which is shown in figure 1, 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" indicator shows that investors are 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 indicator is neutral.

Figure 2. "Smart Money" Indicator/ weekly

Figure 3 is a weekly chart of the S&P500 with the InsiderScore "entire market" value in the lower panel. From the InsiderScore weekly report we get the following two insights: 1) S&P500 weekly score falls to multi year low as insiders are not buying; 2) buying is without conviction.

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 and the current ratio is not particularly revealing; 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


D-man said...


I read your blog for a while now and I know you work with ratios when you follow the dumb/smart money thing (which means that we don't care who are the people behind those ratios).

But in the end, who are these smart money exactly? Is Merryl Lynch smart money? Is Goldmand Sachs smart money? Is PIMCO smart money? Is Joe and Jane dumb money?

I know for instance Goldman Sachs was rather bullish during the entire rally (they had a target for it of 1100, so I assume they followed that and kept buying). That would mean they were rather in the "dumb money" field.


Guy M. Lerner said...


I appreciate the input and recognize that you have been a faithful reader and a willing and insightful commentator on the site; the smart money would be considered institutional money - the kind of investor who would be using the SP100 options as opposed to other vehicles.

I would tend to agree with your premise that it is difficult to know who is who on the playing field these days; a lot of "smart money" lost a lot of money in 2008, etc.; they weren't so smart- were they?

So who or what should we emulate? Some of these sites like TickerSpy might have merit in the sense that you follow portfolios of the "smart money" - but even here there are no guarantees. Ken Heebner in 2008? Not so good. Bill Miller - a bum....

Look how the Insiders did in 2007 and 2008....they were buying at the top and right before the market fell apart in Sept 2008.

The markets change and this is what is so fascinating...I don't have a concrete answer for you but just anecdotal observations.