Does the Federal Reserve have another rabbit to pull out of the hat?
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Several weeks back, we noted that the "smart money" was bearish on the markets, and that higher equity prices would see even more selling extremes amongst corporate insiders. As we look at the data this week, this is exactly what has happened as the "smart money" indicator is at its most extreme degree of selling since November, 2010. See figure 1 below.
Figure 1. "Smart Money"/ weekly
But as we can see in the figure, the "smart money" was wrong. Over the next 13 weeks, the SP500 gained an additional 13%. So what went wrong? As it turns out, November, 2010 coincides with the implementation of the Fed's QE2 bond purchase program.
Now let's fast forward to December, 2012. See figure 2. Once again, the "smart money" was selling to an extreme degree. The US government was facing the fiscal cliff. This was "resolved" as Congress kicked the can down the road in response to a mini - market swoon. While the market welcomed that news positively, which was a foregone conclusion that the "crisis" would be resolved, it really was the Fed's announcement that it was going all in for as long as possible that really ignited the SP500 for a 30% gain in 2013. The "smart money" was wrong, again.
Figure 2. "Smart Money"/ weekly
So is the "smart money" really that bad? Looking at figure 3, we have highlighted the extremes in selling by the "smart money" since November, 2010. Despite the two misses as outlined above (and these were big misses), the "smart money" indicator has done a decent job at identifying intermediate term tops. The common denominator as to why the "smart money" indicator has failed is quantitative easing or perceived market intervention (i.e., jawboning) by the Federal Reserve. So this begs the question: Does the Federal Reserve have the ability to pull another rabbit out of the hat?
Figure 3. "Smart Money"/ weekly
The Fed remains in taper mode, yet market participants still believe that the Fed will do whatever it takes to maintain asset prices. This market dynamic -- i.e., that the Fed has my back -- has yet to be tested. I suspect it will be tested sometime soon, but until it is, investors will continue to believe in the magical powers of the Fed and the mystical powers of QE. A test of the notion that "the Fed has my back" can only come after a market sell off. After a market sell off, the Fed will act or market participants will look to the Fed to act, and it is the success or failure of that bounce that will determine the course of this bull market. In the absence of another asset purchasing program (i.e., QE5), I don't believe the market will power higher. To go higher while the "smart money" was bearish essentially required the implementation of new QE programs, and let's not forget that each successive QE program was bigger and "better" than the last. Once again: can the Fed pull that kind of rabbit out of the hat? I don't believe so.
Despite the new all time highs in the SP500, it has been my contention for the past 4 weeks that we are in a NEUTRAL market environment. A neutral market environment implies that the markets will be ruled by overbought and oversold conditions. Four weeks ago we had a sell signal, and although the market is at new highs, our sell signal was not followed by a buy signal. What would constitute a buy signal? If investors had turned extremely bearish on equities following January's sell off, then we can say that this is a meaningful bottom that should lead to higher prices. Buyers short circuited January's sell off repeating a pattern that has been in place since 2012 where dips have been shallow as investors have anticipated Federal Reserve intervention, which seemed to be timed to limit investors' angst because the markets had pulled back almost 5%. Oh my gosh! In any case and as the data shows, a market that fails to periodically clear itself of the weak hands (i.e., those investors late to the rally) is a weak market, and with 1 buy signal in 2013 alone (when historically over 23 years of data there have been 2.5 per year), this market is vulnerable.
By our measures, the upside should remain limited.
Figure 4 is our composite sentiment indicator. This is the data behind the “Sentimeter". This is our most comprehensive equity market sentiment indicator, and it is constructed from 10 different variables that assess investor sentiment and behavior. It utilizes opinion data (i.e., Investors Intelligence) as well as asset data and money flows (i.e., Rydex and insider buying). The indicator goes back to 2004. This composite sentiment indicator moved to its most extreme position 10 weeks ago, and prior extremes since the 2009 are noted with the pink vertical bars. The March, 2010, February, 2011, and February, 2012 signals were spot on — warning of a market top. The November, 2010 and December, 2012 signals were failures in the sense that prices continued significantly higher. The current reading is neutral.
Figure 4. The Sentimeter
Dumb Money/ Smart Money
The “Dumb Money” indicator (see figure 5) 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 NEUTRAL.
Figure 5. The "Dumb Money"
Figure 6 is a weekly chart of the SP500 with the InsiderScore “entire market” value in the lower panel. From the InsiderScore weekly report: “Market-wide insider sentiment has moved into Strong Sell Bias territory. There was a record number of Weekly Net Cluster Sales this past week and an Industry Sell Inflection generated for the Entire Market, S&P 500 and multiple sectors, but it's important to recognize that there is a seasonal element to some of the selling due to the timing of annual restricted stock awards and vesting events. Presently, the Utilities, Materials, Industrial Goods and Healthcare sectors are displaying the strongest sell bias, followed by Technology and Consumer Discretionary. We note that our market-wide Industry Sell Inflection event has generated a total of seven other times since the March 2009 market bottom, most recently in November 2013, with the market posting gains in the six-month period that followed five times. Given the strong market backdrop and seasonal nature to some of the selling, the activity is not out-of-line with our expectations. That said, some caution is warranted as insider selling volume is clearly elevated. "
Figure 6. InsiderScore “Entire Market” value/ weekly
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