Saturday, January 29, 2011

Investor Sentiment: This Time Will Not Be Different

It was touch and go this week, but in the end and as suspected in last week's comments, the "this time is different" scenario will not play out.  Prices are expected to head lower as the bullish extremes in sentiment unwind.  This should NOT be a bull market top leading to a bear market.  Bear markets come about when "buying the dip" fails.  In other words, this overbought, over bullish market should correct providing a better risk adjusted buying opportunity in the future.  Failure of a bounce to materialize at that point is a harbinger of a bear market.  I expect to see a correction leading to a better risk adjusted buying  opportunity, and this buying opportunity usually coincides with investors turning too bearish (i.e., bull signal).  We are a ways from that point, but we will get there!!

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 is very bullish to an extreme degree. 

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:  "Market-wide insider sentiment improved to its best level since the week ended August 31, 2010 as the market ran to a 27-month high before quickly giving back some gains. The Russell 2000 was the main sentiment driver and the Energy and Healthcare sectors were the main contributors within that group. Volume remained very light as the majority of insiders are locked-up ahead of their companies' earnings announcements, but we did see an uptick in buying in the wake of the market's peak and giveback early in the week. While not a strong signal, insiders nonetheless sent something other than a sell signal for the first time in 20 weeks."
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 69.62%, and this indicator has now turned down two consecutive weeks from its highest level in 10 years.  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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Tiho said...

The market is entering a correction in the short term, but the primary support according to the Dow Theory should hold. Sentiment is very bullish and the market is overbought, but I think we can go a bit higher after the correction. We are in a cyclical bull, but a secular bear, so the run from March 09 lows is becoming quite mature. Therefore, I am not sure how much higher we will go, as majority of the gains are now gone!

Guy M. Lerner said...


Agreed but I don't know enough about Dow Theory; correction ==> then the dip is bought (usually when sentiment turns bearish)==> bounce to probable new highs BUT if that doesn't materialized I would be very careful (of course, we are talking months out here)