Saturday, November 13, 2010

Investor Sentiment: Bear Signal

The "dumb money" and the Rydex investor are extremely bullish.  Company insiders are selling to an extreme degree.  In aggregate, this is a bear signal.

The price cycle is playing out as expected.  Fear has given way to greed.  Greed will lead to fear.  Lower prices finds buyers as the selling dries up.  Higher prices leads to selling as there are no more buyers.  It is the price cycle - that is dictated by fear and greed - that plays over and over and over again in the markets. 

Our buy signal was issued on August 19, 2010, when market participants were fearful, and with market participants bullish to an extreme degree a bear signal is being issued here.  If the market hasn't topped out already, it should do so within a couple of percent of the recent highs.  Rallies should be sold and stops tightened up.  The market is prone to sudden sell offs.  There will be better risk adjusted opportunities to buy in the future.

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) Investors Intelligence; 2) Market Vane; 3) American Association of Individual Investors; and 4) the put call ratio. The "Dumb Money" indicator remains extremely bullish for the fifth week in a row.   

Figure 1. "Dumb Money"/ weekly

Figure 2 is a weekly chart of the S&P500 with the InsiderScore "entire market” value in the lower panel. The value is well below the lower trading band suggesting an extreme selling bias amongst insiders.  From the InsiderScore weekly report: "Insider sales reached a four-year high as trading windows opened at hundreds of more companies and insiders showed a serious appetite for profit-taking. The number of sellers nearly doubled week-over-week and outpaced the number of buyers by a more than 4-to-1 margin. Insiders at S&P 500 companies and in the Technology sector were the most likely sellers, followed by those in the Materials and Industrial Goods sectors."

Figure 2. InsiderScore "Entire Market" Value/ weekly

Figure 3 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 58.15%. Values less than 50% are associated with market bottoms.  Values greater than 58% are associated with market tops.
Figure 3. Rydex Total Bull v. Total Bear/ weekly

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