Introduction

The “dumb money” has turned extremely bullish.

Figure 1 (see below, next page) shows that the “dumb money” has turned extremely bullish.  As stated last week, investors continue to believe in a “sure thing”.  That is, investors believe that this market has only one direction and it is up.  This week, that belief in a “sure thing” is a whole lot stronger.   Unfortunately, such beliefs, which are manifested by bullish extremes in the “dumb money” indicator, work out about 20% of the time for investors.  These are the times when it pays to be a bull or as I have often stated, “it takes bulls to make a bull market”.  Over 20 years of data would suggest that these times occur after major market bottoms like those seen in 1995, 2003 and 2009 and coincide with accelerating economic activity.  With markets at multi year highs and economic growth stagnant at best, the current environment is not conducive to such meteoric gains.  So I am expecting the markets to behave like they do 80% of the time that the “dumb money” indicator turns extremely bullish.  Going forward, gains should be difficult to come by, or to put another way, at some point in the future, we should have the opportunity to buy at lower prices.  From this perspective, our “sure thing” is anything but!

There is one caveat to all this, and it is worth mentioning.  This is December, 2012 or the period that coincides with the announcement of QE to infinity.  The markets took off in 2013  – not on a tide of rising economic activity but thanks to a sea of Federal Reserve liquidity.  It was  that simple.  Here we are in 2014 and the Fed has stated its intention to continue its reduction in asset purchases, so one has to wonder can the markets just power higher in the absence of such intervention.

Now let’s return to figure 1.  The “dumb money” indicator is extremely bullish.  This does not mean that the markets will rollover starting tomorrow.  However, it does mean that a lot investors want in to this market, and at some point in the near future there won’t be any buyers left, and in the vacuum of buyers, then the markets will fall.  From our work, the best time to be a seller is one week after the “dumb money” indicator crosses below the upper extreme band (noted by the arrow on the chart).

To summarize, the “dumb money” indicator is extremely bullish.  The current market environment is NOT conducive to ongoing market gains.

Dumb Money/ Smart Money

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. The indicator shows that investors are EXTREMELY BULLISH.

Figure 1. The “Dumb Money”

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 continues a downside move further into Neutral territory but the rapidity of the move has weakened. This past week, there was improved sentiment within the Russell 2000 but the S&P 500 remained devoid of buyers. The Technology and the Consumer Staples sectors are showing the weakest sentiment while no sector is showing anything more positive than Neutral sentiment. The number of 10b5-1 trigger price Unusual Events is increasing as the S&P 500 continues to mark out new all-time highs. As we noted last week, it’s harder to sustain buying momentum because insiders don’t have unlimited funds and, behaviorally, we know that most insiders transact one-and-done buys instead of multiple buys. Nonetheless, we think the recent slowdown in buying should be viewed as a negative data point because it comes amidst an increase in selling.”

Figure 2. InsiderScore “Entire Market” value/ weekly

$VIX

Figure 3 is a weekly chart of the SP500 with the $VIX data in the lower panel. The black dots on the $VIX data are key pivot points, which are areas of support and resistance. The $VIX has closed at 12.15, and this is just below resistance levels at 12.22.  A close above this level and the rally is likely over.  It was only 2 weeks that the $VIX was closing at multi-year lows.  Multi-year lows in the $VIX late in bull market cycles tend to be signs of complacency. Based upon this, we should expect selling in prices in the near future. Seethis Weekly Sentiment Report.

Figure 3. $VIX/ weekly