Last week, the "smart money" turned bearish to an extreme degree, and this week, they continue as sellers of equities. The "dumb money" continue to be buyers. Hmmm.... In general, this is not a good mix for higher prices. However, there have been some notable bad signals when these conditions were present. In particular, coming off of the March, 2009 bottom and the implementation of QE2 led to continuation of the trend higher despite the bullishness of the "dumb money" and extreme selling in the "smart money". Nothing is perfect! But surveying the current investment landscape, I would venture to guess (and this is not a wild guess either) that we are closer to the end of this investment cycle than the beginning, and we already know that the Federal Reserve has rendered itself irrelevant as Fed policy fatigue has been the response following QE3 and now QE4. To be a bullish you need to answer these two questions: Who or what is going to "save" the markets from a long overdue correction? And what will be that catalyst?
Despite these serious sentiment headwinds, the market has found a floor. Holiday trading, hope for investment funds to magically flow into the market to start the New Year, and the hope and the expectation for a fiscal cliff resolution will keep the market going through the end of the month. But the rubber band wasn't stretched too far at the recent bottom. There aren't any bears to produce short covering. So things should not get too crazy on the upside. However far the rally goes, it will likely be a part of what will eventually be recognized as a market top.
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. If the indicator had stayed bearish for two consecutive weeks, it would have been a bullish signal.
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: "Market-wide sentiment has moved into the Strong Sell Bias zone. Some of the selling may be a reaction to the possibility of higher capital gains tax rates going into effect next year, particularly sales by 10% Owners. Regardless of the motivation for selling, over the past three weeks, there has also been a demonstrable decrease in buying and, more importantly, in the type of buying we feel is Actionable."
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 60.59%. 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