Investor Sentiment: The Best Gains are Behind Us

I am not going to say I told you so because honestly, I had no knowledge of the current outcome.  All I know is that betting against the crowd — when that crowd is extremely bearish in their outlook towards equities — generally works out about 80% of the time with a reasonable draw down.  This time has been no different.  The SP500 has gained nearly 20% from its lows only 4 weeks ago.  While such gains are extraordinary, they really highlight two points.  One, the best, most accelerated gains occur while investors are bearish towards the market.  Two, with investor sentiment turning neutral, it is likely that the best gains are behind us.

As stated last week, seasonal factors, an expected positive resolution to macro economic events, and investors sitting on the sidelines wanting to get into this market will likely be positive factors.  As stated last week and the week before that, dips will be bought, and I don’t see that changing now.  The big change will be the decreasing acceleration in the rate at which gains will occur.

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 shows neutral sentiment, and this is a bull 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:  “Insider trading volumes remained constrained last week as most executives and directors continued to be prohibited from buying/selling until after their respective companies’ Q3’11 earnings report. Activity did begin to pick-up towards the end of the tracking and will continue to do so as more and more companies announce results, but we won’t get a true macro tell for at least a week – if not two weeks. ” 

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 indicatoris 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 57.63%.  Values less than 50% are associated with market bottoms.  Values greater than 58% are associated with market tops.

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

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