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August 09, 2009

Investor Sentiment: Extremely Extreme
by Guy Lerner

Investor sentiment is extremely bullish as the "Dumb Money" indicator has registered its second most extreme reading ever. The current value is only less than the value seen in May, 2003, which was at the start of the last bull market.

The "Dumb Money" indicator is shown in figure 1. The "Dumb Money" indicator 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

I would apply 3 interpretations or scenarios to the current extreme readings in investor sentiment:

1) This is a bull market, and as we know, it takes bulls to make a bull market. Extremes in investor sentiment - just like over bought signals - are irrelevant.

2) Even though prices may be higher over time, the market is likely to consolidate (i.e., trade in a range) over the next couple of weeks; referring back to figure 1 and the 2003 time period, we note that the market actually went sideways for about 13 weeks following the extremely extreme extremes in investor sentiment. I suspect that this will be the most likely scenario for now. There will be a bid under the market. It will be tough to short or bet against this market for the foreseeable future.

3) The last scenario is that the current extremes in investor sentiment will mark the price highs in the major indices leading to the mother of all fake outs. This scenario is still very much on the table, but with an expected bid below the market, I don't see the market making a sudden reversal anytime soon. Market tops are a drawn out affair!

In sum, the bulls remain in control, and despite the bullish extremes in investor sentiment, it will likely be some time before the market rolls over. There may be a lot of believers, and in general, this is not good for higher prices, but these buyers won't give up so easily. As I am not one to chase prices higher, I would still wait for a more risk adjusted entry.

The "Smart Money" indicator is shown in figure 2. 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" is neutral.

Figure 2. "Smart Money" Indicator/ weekly

Guy M. Lerner
http://thetechnicaltakedotcom.blogspot.com/

Disclaimer: Guy M. Lerner is the editor and founder of The Technical Take blog. His commentary on the financial markets is based upon information thought to be reliable and is not meant as investment advice. Under no circumstances does the information in his columns represent a recommendation to buy or sell stocks. Lerner may on occasion hold positions in the securities mentioned in his columns and on the Web site; in all instances, all positions are fully disclosed at http://thetechnicaltakedotcom.blogspot.com/. However, their positions may change at anytime. For more information on any of the above, please review The Technical Take's full Terms of Use and Privacy Policy (link below). While Lerner cannot provide investment advice or recommendations, he invites you to send your comments to: guy@thetechnicaltake.com.

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