I wish I had a nickel for every time I have been told that technical analysis doesn't work or that TA doesn't work because Ben Bernanke is backstopping the markets. I would be a very rich man. Truth be told, my market analysis is a little bit more comprehensive than just TA, and for that matter, my TA is little bit more rigorous than what most are doing. Be that as it may, there were a lot of lemmings and so called smart people very bullish on the markets only a few short months ago. I don't hear you now!! What I do hear is a market looking for a government solution to the fiscal cliff drama. Remember, it was suppose to be a monetary solution (QE3) that would cure the markets most recent spate of selling back in the Spring of 2012. Yes, the expectation of QE3 did stop the tide, but when the ultimate solution -- unlimited QE -- was announced, the market tanked. So what do we have to look to over the next couple of weeks? More drama from Washington. What else will keep the market buoyant? The hope that the drama in Washington will lead to avoidance of the fiscal cliff. The key here is on avoidance because it would be very unlikely that a real solution is forthcoming. A real solution is likely to cause pain, and in this day and age, pain is a dirty word. Nonetheless, the market will likely cheer any agreement even if it just kicks the can down the road a little bit further. But let's be realistic here, more money or fiscal largess isn't going to solve our problems. Growth that is organic will. By blaming this week's sell off on the coming fiscal cliff is another belief by market participants that Washington can fix our economy and our markets. They cannot. For those who believe the solution is more government either in the form of more fiscal or monetary policy, I would point to QE3 and ask, "what happened?".
The sentiment indicators are far from turning bearish (i.e., bull signal). The best way to get there is to have lower prices. This will clear out the weak hands and forge a more meaningful bottom. Anything short of this will be the same old same old.
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) MarketVane; 3) American Association of Individual Investors; and 4) the put call ratio. This indicator is neutral, and just below the extremely bullish level. Bullish sentiment is unwinding.
Figure 1. "Dumb Money"/ weekly
Figure 2 is a weekly chart of the SP500 with the InsiderScore "entire market" value in the lower panel. From the InsiderScore weekly report: "Insider transactional volume has increased recently and for the first time during Q4'12 we're beginning to see sentiment signals within various groups. On an index level; the S&P 500 is showing an unsurprising Sell Bias while Russell 2000 have struck a Neutral stance. At the sector level; most groupings are showing Neutral to Slight Sell Biases, but the Industrial Goods sector is showing a solid Sell Bias and there has been some strong Actionable Buying in Energy and Consumer Discretionary."
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 67.48%. Values less than 50% are associated with market bottoms. Values greater than 58% are associated with market tops. It should be noted that the market topped out in 2011 with this indicator between 70% and 72%.
Figure 3. Rydex Total Bull v. Total Bear/ weekly