Sunday, March 20, 2011

Investor Sentiment: Leading Price Lower

Extremes in investor sentiment were seen over 2 months ago while the high in prices was seen 5 weeks ago.  Often times, indicators of investor sentiment precede moves in the markets.  After all, the markets represent the collective opinions of its participants.  At present, investors are viewing the markets unfavorably, but their opinions are by no means extreme.  In the absence of bearish extremes in sentiment, I would expect equities to remain under selling pressure.

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.   This indicator is neutral. 

Figure 1. "Dumb Money"/ weekly

Figure 2 is a weekly chart of the SP500 with the InsiderScore "entire marketvalue in the lower panel.  From the InsiderScore weekly report we summarize: "A -21% sequential decrease in the number of sellers and the highest number of buyers since the week before Thanksgiving 2010 pushed market-wide sentiment to its best level in seven weeks. Sellers still outnumbered buyers more than 2-to-1 and all of metrics show sentiment worse than the 52-week average, but it was obvious that the market's downward move pushed some sellers to the sidelines (especially at S&P 500 companies) and brought out buyers (specifically at Russell 2000 companies)."

Figure 2. InsiderScore "Entire Market" Value/ weekly  
Figure 3 is a weekly chart of the SP500. 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 65.43%.  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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hettygreen said...

With all the breathless hyperbole in the msm and blogosphere lately, thanks for keeping market sentiment in proper perspective Guy.

I'm curious. What were the indicator readings at the bottoms in October '08 and March '09?

Guy M. Lerner said...

HettyG: What is MSM?

For March, 09 I refer you to:

For October, 2008, the lower prices brought out bearish sentiment, which is a bull signal. Buyers briefly materialized but the signal failed; failed signals generally mean caution or look out below and that is what happened in October, 2008

It is what happens when we get these signals that is important

Guy M. Lerner said...

Got it: MSM = mainstream media