Investor Sentiment: Looking For A Top

This is now the fourth week in a row where investor sentiment, as measured by the “Dumb Money” indicator, remains neutral. When we couple this with the fact that prices on the major stock indices remain below their 40 week moving averages, there is a high likelihood that the market will rollover in the next several weeks. I have previously discussed these observations in the article, “Investor Sentiment: Some Context”.

The “Dumb Money” indicator is shown in figure 1, and it is in the neutral zone. The “dumb money” looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investor Intelligence; 2) Market Vane; 3) American Association of Individual Investors; and 4) the put call ratio.

Figure 1. “Dumb Money” Indicator/ weekly

The bear market rally that started 5 weeks ago will likely stall over the next couple of weeks just as more investors are drawn into the market for fear of missing the “big one”. Why should the cycle of fear and greed be any different this time? While it does take bulls to make a bull market, there are several additional technical insights that suggest that this rally will fail:

1) with the exception of the NASDAQ, which has been our relative leader, prices on the other major indices (i.e., DJIA, S&P500, Russell 2000) have only retraced back to the point where they broke down in early February;

2) measures of market breadth, such as the McClellan Oscillator and cumulative volume, are beginning to negatively diverge from price, and this suggests waning upside momentum.

3) another breadth measure is the percentage of NYSE stocks trading above their 40 day moving average; this is an indicator found in the popular TeleChart software package developed by the Worden Brothers; the “T2108″ indicator is shown in figure 2, and the current value is close to 90% -meaning that 90% of NYSE stocks are trading above their 40 day moving average. Within the context of a bear market or down sloping 40 week moving average, this is an extreme, overbought number that has typically signaled an intermediate term top. Past occurrences are noted with the maroon colored vertical bars in figure 2.

Figure 2. % NYSE Stocks Above 40 Day MA/ weekly

Lastly, for completeness sake, I have included the “Smart Money” indicator in figure 3. The “smart money” indicator is a composite of the following data: 1) public to specialist short ratio; 2) specialist short to total short ratio; 3) SP100 option traders. The “smart money” remains neutral and this is surprising considering the 20 plus percent run in the major indices over the past 4 weeks.

Figure 3. “Smart Money” Indicator/ weekly

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