Investor Sentiment: It's All Good, but...

The price action this past week was fabulous as the market found its winning ways on the back of AAPL earnings and a Federal Reserve that remains as compliant as ever. It's all good, and no doubt this can only mean one thing. It's clear sailing ahead. But not so fast. From this perspective the price action looks more like a market top than a launching pad for another bull run. Huh? Yeah, a market top. The lack of bullish signals, where there are more bears than bulls in any time frame beyond 60 minutes, is consistent with a market top. Price action built on this kind of foundation is prone to fail as the weak hands never get taken out of the market until the very end.

As a reminder, the 2011 market top took over 6 months to develop. The SP500 traveled in a narrow 75 point range before dropping 20% over a 4 week period. The current price range is 65 SP500 points, and the current market environment has many similarities to 2011. The top can best be described as a period of discussion. Is the economy sputtering? Will the European contagion effect the US economy? Will the fiscal cliff be realized? And of course, the number 1 topic of discussion and the only one that matters: will there be QE3? This all sounds familiar.

This is a range bound market. For those investors who want to act like traders, this means to sell at or near the top of the range and buy near the lows. For those investors, who want to act like investors, "sell in May" may be an appropriate strategy. There will be better opportunities ahead.  

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 now neutral.

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 trading volume was seasonally light last week as most insiders remained on the sidelines, waiting for their respective companies to report Q1'12 earnings. There was no follow through in the Russell 2000, where a week earlier an Industry Buy Inflection was triggered, as activity quickly waned and a rather typical seasonal imbalance in the ratio of sellers to buyers returned. We should begin to see significant insider trading volume near the end of next week or the beginning of the following week."

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 65.34%. This is the second week in a row that the indicator has turned down week over week. 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 71%.

Figure 3. Rydex Total Bull v. Total Bear/ weekly

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