Investor Sentiment: There is no free lunch

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The article below is a guest contribution by Guy Lerner, writer of the Technical Take blog.

It is called the price cycle, which is the path that prices take from low to high and back to low again. I characterize the price cycle utilizing investor sentiment. At the lows, investors are in despair and at the highs, there is a sense of jubilation. This time played out no differently. 8 weeks ago, the market moved significantly higher amidst grave economic concerns, and 3 weeks ago, it started to fall apart once the pundits gave the all clear. It doesn’t work that way all the time, but what does work is developing a strategy where you assume risk when others are unwilling. I would contend that risk was less 8 weeks ago then today despite the higher prices. This is just another way of saying that there is no free lunch.

For the coming week, look for swings in both directions as the Thanksgiving Holiday and end of the month mark ups keep a floor under prices. Risks remain in the headlines as Europe and the Congressional Super Committee will dominate the news. These people, no matter how misguided, are in the business of providing good outcomes. There is always hope, and the Santa Claus rally is just around the corner and so is the next data point or breaking news story. From a sentiment perspective, there is little edge other than to say that the highs have likely been seen for this price cycle.

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.

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: “The number of sellers last week was just off the prior week’s six-month high, but the number of buyers increased 20% sequentially, allowing sentiment to eke more into the middle of the neutral rating band and further away from bear territory. To see such neutral sentiment during a period of high transactional volume is a little unusual and perhaps that’s an indication that insiders as a group are a bit confused by macro events at the moment.”

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 62.47%. 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

Let me also remind readers that we are offering a one-month free trail to our Daily Sentiment Report, which focuses on daily market sentiment and the Rydex asset data. This is excellent data based upon real assets rather than opinions.

Source: Guy Lerner, Technical Take, November 19, 2011.

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