Investor Sentiment: Happy Thanksgiving!

In this holiday shortened week, there won't be much to gleam from market action in the coming week.

Over the past couple of months, Mondays have been kind to the bulls. Wednesday will be light as traders ready for Turkey Day on Thursday. Friday is another snooze fest that seems to go to the bulls --why spoil a great American holiday?

Will this week be another repeat of the last two where the best gains are on Monday and then the market struggled all week long? It seems plausible. Stock sponsorship (i.e., volume) has been pathetic, and I can't see that improving this week either.

Over the longer term or beyond next week we say what we said last week:

"The major equity indices are in a topping process. This implies a trading range at best. There is risk of a down draft as markets "fueled" by the proverbial "liquidity" are prone to quick sell offs. The outlier trade is a market blow off or a spike in prices, and I do not rule this possibility out because of the ongoing downtrend in the Dollar Index. It is possible but it is not the high odds play. This is not the market environment that will take you from here to there."

Have a Happy Thanksgiving!

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 three insights: 1) after stripping out the buying in the financial sector from Regional Bank insiders, the "entire market" score was the second worst weekly score since June, 2007; 2) Technology and Basic Material were the driving forces of negative sentiment; 3) insider buying in the Regional Bank sector has been noteworthy and we highlighted this in the article: "The New World Of Investing".

Figure 3. InsiderScore Entire Market/ weekly

Figure 4 is a daily chart of the S&P500 with the amount of assets in the Rydex Money Market Fund in the lower panel. When the money market fund is flush with cash, one can assume that the Rydex timers (like market participants in general) are fearful of market losses. From a contrarian perspective, these are good buying opportunities. When the amount of assets are low (like now), these market timers are all in; one should be on the lookout for market tops. There is little buying power left. As of Friday's close, assets in the money market fund remain very near their lowest levels since the rally began in March, 2009.

Figure 4. Rydex Money Market/ daily

The Greats Of The Blues: Walter Horton

Harmonica player Walter Horton, better known as Big Walter, was born in Mississippi on April 6, 1917. He spent much of the 1930's and 1940's travelling and playing through the South, and his earliest known recording was in 1939. He arrived on the Chicago Blues scene in the early 1950's where he backed Muddy Waters and other Mississippi Delta Blues performers who had traveled north for a better life in the big city. In the 1960's, the white youth of America "discovered" this harmonica virtuoso, and in the 1970's, he toured the world and frequented the festival circuit. He died in 1981 of heart failure.

There is more that is not known about Big Walter than is known. He was said to be a quiet and shy man, who was also nicknamed "Mumbles" and "Shakey". Big Walter boasted that he taught Little Walter and the original Sonny Boy Williamson to play harmonica. Most Blues historians doubt this contention. What isn't contested is this: Big Walter was one of the most influential harmonica players in the history of the Blues. His tone or big sound is instantly recognizable. Nobody played the harmonica like Big Walter.

To read more about the life of Big Walter Horton, check out this link at Wikipedia.

Bond Sentiment: Very Interesting

I am definitely on board with the idea that longer dated Treasury yields are headed lower, and I am beginning to warm up to the idea that this could be meaningful, tradeable move.

Now from the missives of David Rosenberg, we have the Barron's Big Money Poll from Fall, 2009. The most loved asset class: equities. As it turns out, Treasuries are the least loved and the most hated - winning both titles by a long shot. See figure 1.

Figure 1. Barron's Big Money Poll

Very interesting.

Rydex Market Timers: Persistence

The Rydex market timers remain persistent in their desire to buy the dip.

Figure 1 is a daily chart of the S&P500 with the amount of assets in the Rydex Money Market Fund in the lower panel. This value is now at its lowest point since the rally began in March, 2009.

Figure 1. S&P500 v. Rydex Money Market/ daily

Figure 2 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. There is minimal change from yesterday.

Figure 2. Rydex Bullish and Leveraged v. Bearish and Leveraged/ daily

Rydex Market Timers: At It Again

The Rydex market timers are buying the dip to an extreme degree.

Figure 1 is a daily chart of the S&P500 with the amount of assets in the Rydex Money Market Fund in the lower panel.

Figure 1. S&P500 v. Rydex Money Market/ daily

Figure 2 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.

Figure 2. Rydex Bullish and Leveraged v. Bearish and Leveraged/ daily

The New World Of Investing

In this new era where fundamentals seem to matter less and less, here is an ETF that seems to fit right in with that theme. It is the SPDR KBW Regional Banking (symbol: KRE) ETF.

It isn't lost on me that the local or Main Street economy is in the toilet. All I need to do is drive down the nearby 4 lane road with all the malls and strip centers to know that "things" aren't that good, and they are unlikely to improve any time soon. After all, how many tortilla restaurants and nail shops can one locale support? Who is going to fill all those empty stores?

Like all of you, I read about the increasing number of bank failures, the impending commercial real estate crisis, the high unemployment rate, and the increasing number of home foreclosures just to mention a few of our economic pleasantries. It would seem that none of this is good for the regional banks, who have been treated as pariahs as the Wall Street Money Center banks garner all the monetary stimulus from Washington. But when looking at the charts, the SPDR KBW Regional Banking ETF or KRE is the kind of equity that stands out.

Welcome to the new world of investing. The fundamentals are stinky, but the chart looks great. Maybe all those fundamentals are baked in to the cake?

Before looking at the charts, here is a CNBC video of banking analyst Meredith Whitney; the video is interesting in and of itself, but what caught my attention occurred just before the 5 minute mark when she spoke about last year's trade and this year's trade in the banking sector. (Thanks to Trader Mark at FundMyMutualFund for bringing the video to my attention.)

Last year's trade was to go long the Money Center Banks and short the Regional Banks, and in essence, that is how things shaped up as the big banks gained over 100% from the March lows and the Regional Banks only notched a 50% gain. Whitney now believes that the two sectors will converge although she does stop short in that she does not give an endorsement for the regional banks.

Another factor to consider is insider buying. According to InsiderScore, there has been "buying at battered Regional Banks and in other less glamorous pockets of the Financial sector," and this buying has been to an extreme. One caveat, however, is that financial company insiders timed their buys poorly in the recent bear market.

With this in mind, let's look at two charts!

Figure 1 is a weekly chart of KRE. Price is basing along the 40 week moving average, which is now turning up. A weekly close above the pivot low (at 21.08 and marked with blue up arrows) would be a positive, and this would also represent a close over 3 pivot low points, which I would also view positively. A weekly close over the trend line formed by two prior pivot highs (at 22.43) would likely catapult prices to the $30 level.

Figure 1. KRE/ weekly

As far as a stop loss goes, I would look at a monthly chart. See figure 2. I would use one of two things: 1) either a monthly close below the pivot high point at 20.86; or 2) a monthly close below the simple 10 month moving average.

Figure 2. KRE/ monthly

In sum, I like the Regional Banks and the KRE. It has been a relative under performer, and maybe some of that "hot" may rotate to this sector. Insider buying is a plus as well.

Just Sell Something, Please!!

The act of selling cannot be underestimated. Selling is just as important as any other decision (i.e., buying or money management) involved in trading, but it seems to get less attention in the world of market punditry. I guess it is just better for the ego to say, "I was there. I bought XYZ stock at the bottom tick." However, a buy recommendation is only good if you sell some time later at a profit, and of course, we want that trip from the buy to the time we sell to be accompanied by a tolerable draw down.

Buying the bottom tick and selling the top tick are noble, but unrealistic goals. Of course, we can try for perfection or more realistically, we can try to determine when there might be a good time to sell. This helps to capture profits (or avoid losses) and make the most of our time in the markets.

One of the strategies that I use is to determine when to sell is to look at negative divergences. Why use negative divergences? Negative divergences tend to show up at market tops, and their presence is a sign of slowing price momentum.

I presented this concept before in an article on the 10 year Treasury yield, which was written on June 15, 2009. First, I determine the presence of negative divergences between an oscillator that measures price and price itself. Then, I count the number of negative divergences that occur over a 13 week period. This produces the indicator in the bottom panel of figure 1, which is a weekly graph of the yield on the 10 year Treasury bond (symbol: $TNX.X). Negative divergences are noted by the pink markers on the price bars.

Figure 1. $TNX.X/ weekly

When there are 3 or more negative divergence bars occurring over a 13 week period, the indicator flashes red, and as you can see, yields on the 10 year Treasury are better sold than bought. In fact, the recent sell signal occurred at a yield of 3.789%, which is the second highest closing yield in the last 22 weeks. Good timing!

More importantly and for our purposes of determining a window or good time to sell, this pattern of multiple negative divergences is consistent enough across multiple assets over the past 90 years. It warrants our attention. Does this pattern identify every market top? No. Remember, I am not looking to identify secular or cyclical tops anyway. I am just trying to identify a good time to sell.

No one strategy is perfect and no one strategy covers every market circumstance, and a cluster of negative divergences is no different. What is clear is that a cluster of negative divergences occurs late in a price move. It may signal a market top. On the other hand, the failure of this signal to lead to lower prices in either the short or intermediate term, will typically lead to an acceleration of prices higher, which would be consistent with a market blow off. These concepts are best illustrated by looking at figure 2, a weekly chart of the yield on the 10 year Treasury (symbol: $TNX.X) with our divergence indicator in the lower panel. The time period under consideration is from 1994 to 1995.

Figure 2. $TNX.X/ weekly/ 1994 to 1995

From point 1 to point 2, Treasury yields moved about 50% higher, and after such a strong move, a cluster of negative divergences showed up at point 2. Over the next 15 weeks, yields moved in a trading range as momentum slowed. At point 3, yields broke out of the trading range and bolted higher in what appears to be a market blow off. At point 4, we have another cluster of negative divergences, and at this point, the market put in a top that saw prices trade all the way back to levels seen 3 years earlier.

So the first negative divergence cluster (point 2) signaled a trading range, which led to higher prices and the second cluster of negative divergences (point 4) was consistent with a market top. Is there anyway that I could have distinguished such different outcomes? The answer is probably no. But that is ok because I am not looking to identify the top tick. I would have been a seller at point 2 because I cannot distinguish point 2 from point 4. Selling when there are multiple negative divergence bars protects profits; it does not "call" a market top.

Another way to navigate these junctures would be to use a moving average cross over system to exit the market during those times when there are multiple negative divergences. The cluster of negative divergences would serve as a filter and then you use the cross of a faster moving average below a slower one to be taken out of the market. This assures that you won't sell at the highs, but it may prevent premature selling.

But if you get out of a position, you must have a way to get back into the market because you may have sold prematurely. One suggestion would be to get back into the market on a close above the high of the recent negative divergence bar. There is no right or wrong here, but selling is just good insurance. Playing good defense leads to consistent and profitable trading.

Another example comes from the Dow Jones Industrial Average (symbol" $INDU). See figure 3 a weekly chart from the 1935 to 1937 time frame. From point 1 to point 2, the Dow Industrials gained approximately 60% over 60 weeks. At point 2, the first negative divergence cluster appeared leading to a short (i.e., in both depth and duration it was less than 10%) pullback. At point 3, another negative divergence cluster appeared and this lead to a bit deeper (i.e., greater than 10%) pullback. The negative divergence cluster at point 4 coincided with the market top which lead to a 45% correction of the prior move.

Figure 3. $INDU/ weekly/ 1935 to 1937

Per my comments above, I would have been a seller at point 1 and point 2, yet I would have gotten back in on a close above the highs of the negative divergence bar. The last cluster of negative divergence bars (at point 3) would be another place to sell, and there was no further action after this as the market fell apart.

So why is this discussion regarding selling relevant? As you can guess, after a 50% move in the markets over the past 8 months, I am starting to see a cluster of 3 negative divergences in many of the ETF's that I follow and that I have discussed in these pages. These ETF's are listed in the following table. Column 1 lists the ETF's by symbol; column 2 is the high of the recent negative divergence bar; column 3 notes a daily or weekly close over the high of the negative divergence bar; if column 3 is left blank, then prices have yet to close over the highs.

Table 1. Negative Divergence Clusters

It is interesting to note that the QQQQ's, GLD, and FXI - that's tech, gold and China or everybody's favorite ETF's - have each made a weekly close above the high of the recent negative divergence bar. This is interesting and maybe it implies a blow off top, and it should be noted that this was the source of my reference to market blow offs in this week's wrap up on investor sentiment.