Saturday, May 29, 2010

Investor Sentiment: The Fat Pitch

I am not a baseball person, but we all know what a "fat pitch" is. It is an easy one to hit. It doesn't mean you will always hit it or even get a homerun, but if you see a "fat pitch" coming, you better take a swing. Investor sentiment has turned bearish here, and this is our "fat pitch". This is a bullish signal because if the market turns higher, we are likely to see accelerated gains over the time that investors are bearish.

In the article, "Putting A Bullish Signal In Context", I make the case for why we should pay attention to investor sentiment. If the bullish extremes that we had only a couple of weeks ago don't have you convinced (see "The Great Unwind" written on May 8, 2010), then you should go back and read this article which was written on March 8, 2009 (note the date). When investors are bearish and the market turns higher, the gains can be rather significant over a short period of time. It works that way about 85% of the time. Unfortunately, the failures can be rather spectacular, too.

So if you are looking for that sure thing, then this is not for you. There are no guarantees here or predictions that the market is going higher just because investors have turned bearish. It doesn't work that way. However, what we do know is that the majority of investors are wrong most of the time. If you don't believe this, then you were probably buying the bull several weeks ago. But I digress. There is no way to predict if the markets go higher or why they might even go higher. I can only choose when to put my money to work. Now is that "fat pitch". The ball is coming to the plate. I don't know if I am going to hit it out of the park or strike out. But I am ready to swing. Are you?

The "Dumb Money" indicator (see 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 is bearish and this is a bullish signal. This is the first bullish signal since March 8, 2009.

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: "Sentiment Shifts To Bullish, But Questions Of Conviction Linger".

Figure 3. InsiderScore/ weekly "entire market" value

Figure 4 is a weekly chart of the S&P500. The indicator in the lower panel measures all the assets in the Rydex bullish oriented equity funds divided by the sum of assets in the bullish oriented equity funds plus the assets in the bearish oriented equity funds. When the indicator is green, the value is low and there is fear in the market; this is where market bottoms are forged. When the indicator is red, there is complacency in the market. There are too many bulls and this is when market advances stall.

Currently, the value of the indicator is 49.08%. Values less than 50% are associated with market bottoms.

Figure 4. Rydex Total Bull v. Total Bear/ weekly

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San said...

DOW JONES weekly triangle pattern

Thank you

hettygreen said...

Thanks Guy. I'm more interested in what the smart money is doing at the moment as I like to think I'm in this category. If it is neutral and sitting out a potentially positive move, so am I. Smart money gets bullish then my tune may change. "May" being the operative word because I'm not sure any of this behaviour is actually smart anymore when those eccentrics staying in cash or its near equivalent "may" be seen as geniuses by the time this is all over and done with (years from now).

San said...

Ascending Triangle in 30 minutes chart of DOW JONES

Thank you

Guy M. Lerner said...

hetty: 1) not a perfect world; 2) another way to play it is to just reduce your market exposure, which you are doing by sitting on the sidelines

Anonymous said...

Hi Guy, have always enjoyed your work. But if you look at it objectively, haven't the dumb money been right to be bullish the past 12 months? And the smart money been wrong for being neutral to bearish during the same time?

Anonymous said...

Re Figure 1 you will note that in the last qtr 2007 and 1 st qtr 2008this "fat pitch" did not work out.
I know where you are going with this ,but like all these "indicator" based methods they fail in the face of trend change.There's no easy answer to this as we both know ,but right now I still want a deeper dip to be back inot equities and I want it to be a dip based on more outright fear. The retail unit investment funds have not confirmed a level of fear that I'm happy with.

D-man said...

I'm taking note; thanks Guy.

Guy M. Lerner said...

Anon #1:

your question: hasn't the dumb money been right the past 12 months and the smart money wrong? A couple of weeks ago around the time of the market topping out, I wrote that the SP500 had gained 48% since the March 2009 lows, which at the time was 62 weeks ago. Obviously, this supports your idea that the dumb money has been right all along. HOWEVER, let's break the gains down; that is, when did they make that money?

From the March lows to the top it was 62 weeks. For 48 out of 62 weeks the dumb money indicator showed extreme bullishness -- so once again the dumb money was right. HOWEVER, what did the market do? During those 48 weeks the SP500 gained a total of ZERO points. So the 48% gain was concentrated during the time (those 14 other weeks) the indicator was neutral or bearish.

Let me state this loud and clear because this is the concept folks have a hard time getting their hands around: 1) I don't pretend to predict market direction; 2) but I do ask myself one question - what market environment do I want to put my hard earned money to work in?

thanks for the interest

Guy M. Lerner said...

Anon #2:

that's right....the indicator failed horribly and truth be told it does that about 15% of the signals....and you are right failures of the indicator will often lead to changes in trend ...that is very important to note...failures aren't the end of the world but they do contain very, very important information

But see my comments above about not predicting the market but about where do I want to put my money to work ....which market environment is best

I would agree with you that a more deeper oversold or extremes in bearish sentiment would be ideal and having the smart money bullish would be even better. Thus I still think ( but remember it is not what I think but what the market does that is important) we will get that right shoulder of the head and shoulders top....but honestly I don't know nor does anyone else....but I know where and when I want to place my bets

San said...

ORACLE CORP weekly and hourly view

Thank you

Anonymous said...

I for one can accept this as a short-term bullish condition... the $BDI has been crawling up strongly for months now.

But I wouldn't call this a fat pitch for anything more than a short-term movement. All the doomsaying in the news over the past couple weeks did have some substance behind it.

Anonymous said...

I don't get it. You're saying this is a "fat pitch" bull signal. Yet a few days ago the blog was about a bearish head/shoulders setting up. Which is it?

Anonymous said...

we are not even close to the "fat pitch". Using same method we had "fat pitch sell signal" since last year and yet the market gained hundreds of points. You can have this "fat pitch buy signal" for weeks and even months and market will still keep going down. So this is not a "fat pitch" in any stretch of imagination. Wait for real bearishness for proloned time before claiming "fat" one

Guy M. Lerner said...

with regards to "fat pitch" v. bearish signal from head and shoulders top, I would say the following and I believe I stated the following:

1) I have no knowledge as to the significance of a head and shoulders top --in other words, what does it mean? As I don't know, It does not factor into my trading

2) But I suspect it factors into the trading of others

3) so the formation of a head and shoulders top doesn't mean anything to me

4) if I can use the short sighted outlook of many market onlookers, there was a widely publicized head and shoulders top last summer that preceded the market going higher - oh my god, what is it going to be this time?

5) I don't see anything incongruous regarding a fat pitch that is coming down the pike and a head and shoulders top that has yet to form


No doubt this sentiment stuff gets people in a tizzy--once again I cannot predict the future (which obviously hard for people to come to grips with) and I can only control when I want to put my chips on the table; think of it as a game of black jack

San said...

Euro vs Usdollar moving in a channel with upside possibilities

Thank you

San said...


Anonymous said...

Hey! How fat's that pitch now?