Should We be Worried about ‘Smart Money’ Leaving Stocks?

Uh-oh. The ‘smart money’ is selling stocks. It rarely pays to bet against the smart money, which includes insiders and hedgers with deep pockets and big research budgets. Should we be worried about their stock market exodus?

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness.”

Charles Dickens classic novel “A Tale of Two Cities” describes London and Paris during the French Revolution, but it could also be applied to Wall Street post 2009.

It is the ‘best of times’ as the S&P 500 (NYSEArca: SPY), Dow Jones (NYSEArca: DIA) and Russell 2000 (NYSEArca: IWM) move from one all-time high to the next. Even the Nasdaaq (Nasdaq: QQQ) is within striking distance of its all-time high.

It is also the ‘worst of times’ for many permabears, who continue to trash talk every rally … and get crushed.

Some of you may remember my inflammatory message for stock market bears published in the July 13, 2014 Profit Radar Report:

Here’s a message for everyone vying to be the next Roubini: A watched pot doesn’t boil and a watched bubble doesn’t burst. The stock market is not yet displaying the classic warning signs of a major top. There will be a correction, but the bull market won’t be over until most bears turn into bulls or the media stops listening to crash prophets.”

My bullish conviction was rooted primarily in extreme investor pessimism (reflected by the following July 2013 headlines) and the absence of the one ingredient that foreshadowed the 1987, 2000 and 2007 crashes (more details here).

  • MarketWatch: “If ever there were a time for a stock sell signal, it’s now”
  • CNBC: “Market will crash, just don’t know catalyst: Faber”
  • Reuters: “Billionaire activist Carl Icahn says ‘time to be cautious’ on U.S. stocks?”
  • CNBC: “I’m selling 6 times more than buying: Wilbur Ross”

Today, we are back at (or near) all-time highs and read headlines such as: “Why the smart money is bailing out of the bull market.”

Indeed, the ‘smart money’ is selling stocks as the ‘dumb money’ is rushing in.

Is this bearish? If so, how bearish is it?

Here is a look at six different sentiment gauges consistently tracked by the Profit Radar Report.

Of the six Profit Radar Report staples only four show extreme optimism:

Newsletter writers polled by Investors Intelligence (II) are the most bullish since June 2014 and active investment managers (polled by NAAIM) haven’t been as bullish since November 2013.

The VIX is low, but needs to shed another 20% before reaching last year’s extreme.

The CBOE equity put/call ratio and CBOE SKEW are only in midly bearish territory.

The media seems somewhat suspicious of new highs, but not nearly as bearish as in June/July 2014.

To be fair, a number of ancillary sentiment gauges match the kind of sentiment extremes seen in December 2010 and 2013.

My interpretation is that current gains will soon be given back, but any correction now or in the near future is likely to be followed by new recovery highs later on.

What’s the benefit of following the above six sentiment gauges?

Here is a more detailed track record published in the the December 2014 Sentiment Picture (the biggest reason to worry about stocks right now is listed at the bottom of this article):

Throughout 2014 many analysts, market timers, the media and ‘experts’ opined that the bull market is on borrowed time, largely because investor sentiment has been extremely bullish. Here are two examples:

  • Title: The boys who cried wolf: Crash prophets on the rise – Yahoo on May 2:

    Article excerpt: “The Dow Jones closed at an all-time high, which doesn’t change the views of the collection of Cassandras calling for a stock market crash. This group, including esteemed figures like Jeremy Grantham and Marc Faber have been emerging from their bomb shelters with relative frequency over the last month to reiterate their bearish views and insist they weren’t wrong with earlier calls, just early.”

  • Title: If ever the stock market flashed a ‘sell’ signal, it’s now – MarketWatch on July 9

    Article excerpt: “Sentiment indicators such as Investors Intelligence are at historic highs (that is bearish), and the RSI Wilder indicator is telling us the market is seriously overbought. Yes, the market can still go higher, but it’s on borrowed time. Don’t believe me? When you are standing 17,000 points in the air at the top of Dow Mountain, and the market is priced for perfection, there is nowhere to go but down.”

This widespread display of pessimism has been baffling and unfounded based on our set of sentiment gauges. At no point in 2014 did optimism reach levels suggestive of a major top. As the small selection of recent Sentiment Picture observations shows, an objective and in depth analysis of investor sentiment has persistently pointed to higher prices.

November 30 Sentiment Picture: “Investor sentiment is not at the kind of extremes usually associated with major market tops. Seasonality may draw prices lower temporarily, but the majority of sentiment gauges point towards higher prices later this year and/or early next year.”

October 31 Sentiment Picture: “In short, investor sentiment allows for further up side.”

September 25 Sentiment Picture: “Few sentiment gauges were at extremes on September 19, when the Dow Jones, S&P 500 and Nasdaq reached their new highs. If this selloff is commensurate to the lack of sentiment extremes at the actual high, it should be on the shallow side.”

August 29 Sentiment Picture: “The overall sentiment picture is fractured, and void of the ‘all in’ mentality seen near major market tops. Isolated extremes cause only small pullbacks here or there.”

The December Sentiment Picture shows a small up tick in ‘dumb money confidence’ (AAII, NAAIM) and complacency by option traders (CBOE Equity Put/Call Ratio). The CBOE SKEW is elevated.

Those readings could contribute to a pullback, but optimism is not pronounced enough to be indicative of a major top.”

The Biggest Reason to Worry about Stocks Right Now

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013 and 17.59% in 2014.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

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Assessing QE Bull Market Longevity Based on Investor Sentiment

The Federal Reserve’s liquidity policy has changed the game. Those who don’t adjust to the new rules will become dinosaurs. The interpretation of sentiment indicators is one of the things that changed. Changed yes, but obsolete no.

Is investor sentiment still a valid contrarian indicator in the Fed-manufactured liquidity rally?

The short answer is yes, but …

But what?

I believe that investor sentiment (as contrarian indicator) is an important piece of the puzzle of the market-forecasting picture, but it needs to be recognized that QE has altered money flow and how investors feel about stocks (NYSEArca: VTI).

The QE domino effect changes how sentiment should be used and interpreted.

Here’s the value sentiment indicators bring to the table in a QE market. See if you can find a pattern.

Excerpts are taken from the monthly Sentiment Picture, published by the Profit Radar Report:

The beginning of 2013 saw some slight sentiment poll extremes, but actual money flow indicators reflected indifference. In other words, investors didn’t ‘put their money where their mouth’ was.

This changed in May. The May 19 Sentiment Picture noted growing optimism, particularly among money flow indicators, and warned that: “Risk is rising and the tipping point where the market is running out of buyers is nearing.”

For easy comparison, the S&P 500 (SNP: GSPC) below shows S&P 500 daily bars along with Sentiment Picture forecasts.

The S&P 500 corrected after the May Sentiment Picture and came back to new highs on August 2.

The August 18 Sentiment Picture focused on whether the August 2 high marked a major market top and concluded that: “A major August top is possible, but not probable.”

The S&P 500 (NYSEArca: SPY) rallied to a new high in September, and the September 27 Sentiment Picture asked if the September high marked a major top?

September 27 Sentiment Picture conclusion: “Although current sentiment doesn’t preclude lower prices, the lack of bullishness at the September highs suggests higher prices ahead eventually.

The chart below shows the actual September 27 Sentiment Picture (without the commentary). The S&P 500 is plotted against five different sentiment gauges to provide a comprehensive sentiment analysis.

It shows the VIX (Chicago Options: ^VIX) near the lower end of the range. But that’s meaningless. Various 2012 Sentiment Pictures put the VIX (NYSEArca: VXX) on probation since it has lost its contrarian indicator mojo.

The other four gauges (CBOE Equity Put/Call Ratio, SKEW Index, % of bullish advisors and % of bullish investors) showed no notable extremes.

The October Sentiment Pictures (forgive me for keeping this chart exclusive for Profit Radar Report subscribers) shows an obvious up tick in bullishness, especially for the SKEW Index and the percentage of bullish investors.

Previous bullish extremes weren’t enough to trigger a market top call. Is last week’s significant up tick enough?

The companion article to the subject matter of sentiment addresses this question:

Do Current Sentiment Extremes Allow for Another 20% Rally?

Simon Maierhofer is the publisher of the Profit Radar Report.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE Newsletter.

 

Smart Option Traders ‘Smelled’ the Latest Bounce

The Volatility Index (VIX) has not lived up to its contrarian indicator reputation, but there is another CBOE options index that’s provided some noteworthy signals. Say hello to the options indicator of the future – the SKEW.

A pilot literally monitors dozens of controls to navigate the aircraft safely through the air.

Like a pilot, the Profit Radar Report constantly monitors dozens of different stock market gauges.

Once a month, the Profit Radar Report publishes the Sentiment Picture. Radar like, the Sentiment Picture searches for sentiment extremes.

Shown below is the May 2013 Sentiment Picture (published on May 19), which plots the S&P 500 against five different sentiment gauges:

1) CBOE VIX
2) CBOE SKEW
3) CBOE Equity Put/Call Ratio
4) Percentage of bullish advisors polled by Investors Intelligence (II)
5) Percentage of bullish investors polled by the American Association for Individual Investors (AAII)

After many months of average readings, the May Sentiment Picture finally showed some extremes. Most notable were the up tick in the SKEW and the drop in the equity put/call ratio.

Unlike polls, the equity put/call ratio is an actual money flow indicator. It showed that investors are putting their money where their mouth is and indicated that risk for bulls was rising.

The actual sell signal was triggered based on technical analysis on May 28 with a target of 1,594 – 1,598 for the S&P 500.

The sell signal proved correct, but it was in contradiction to a bearish SKEW extreme, which is generally bullish for stocks.

On May 28, the SKEW was about the only indicator that suggested higher stock prices. Although the SKEW is quite accurate (see green and red lines on the second chart) its message was simply overruled by the majority of bearish indicators (but its message was only tucked away, not forgotten).

The SKEW – an options-based index like the VIX – in essence estimates the probability of a large decline. A reading of 135+ suggests a 12% chance of a large decline (two standard deviations). A reading of 115 or less suggests a 6% chance of a large decline. In short, the higher the SKEW, the greater the risk for stocks.

The second chart plots the S&P 500 against the SKEW only.

A week later the lonely SKEW signal received backup by extremely bad breadth. Breadth was so bad, it’s actually good.

The June 6 article iSPYETF article noted a NYSE Advance/Decline Ratio that’s usually seen at market bottoms. Now there were two – the NYSE A/D ratio and the SKEW.

Both gauges have a good track record and on June 6 stocks staged a bullish intraday reversal after nearly touching the 1,598 down side target. It seems like options traders were the first to ‘know’ that a bounce was forthcoming.

A pilot is taught to always trust his instruments, not his instincts or emotions. Investment gauges aren’t as reliable as aircraft instruments, but investors should trust them much more than their own emotions. Does the bounce have legs?

The ‘instruments’ are telling me right now that stocks need to move above resistance (the lower lows, lower highs sequence has yet to be broken) or below support to trigger the next move. This may sound vague, but sometimes the market lacks clarity and when that happens it’s smart to stay on the sidelines.

It’s better to miss a trade than to lose money on a trade. The job of the Profit Radar Report is to spot and profit from high probability trades.

Sentiment: Risk is Rising As Correction Concerns Are Fading

Investors have been expecting a correction since the last and steepest leg of the rally started in mid-April. Surprise! There hasn’t been a correction in over a month and investors are starting to think there won’t be one. It pays to stay alert when most become complacent.

When buyers become scarce prices fall. This facet of the supply/demand principle applies to every market, including the stock market.

How can you monitor the supply of buyers? There is no foolproof way, but investor sentiment and money flow data are a good gauge.

The Profit Radar Report consistently monitors dozens of different sentiment and money flow stats and publishes a broad summary every month (called the Sentiment Picture).

This year’s sentiment readings have been the most schizophrenic I’ve ever seen.

It started in February when sentiment polls conducted by Investor’s Intelligence (II) and the American Association for Individual Investors (AAII) registered extreme readings. Those extremes, however, were not confirmed by actual money flow indicators (such as the option put/call ratio, margin debt and money invested in bullish vs bearish funds).

The February 15, Sentiment Picture drew that conclusion: “Investors may not be putting their money where their mouth is.” Money flow discredited bullish sentiment readings and suggested further up side.

The media is another contrarian indicator that falls into the sentiment category. There is no media index, but if you study the headlines every day you develop a feel for media sentiment.

The March 10, Profit Radar Report noticed that: “The media seem to embrace this rally only begrudgingly and is quick to point out the ‘elephant in the room’ – stocks are only up because of the Fed. Below are a few of last week’s headlines:

CNBC: Dow Breaks Record, But Party Unlikely To Last
Washington Post: Dow Hits Record High As Markets Are Undaunted By Tepid Economic Growth, Political Gridlock
The Atlantic: This Is America, Now: The Dow Hits A Record High With Household Income At A Decade Low
CNNMoney: Dow Record? Who Cares? Economy Still Stinks
Reuters: Dow Surges To New Closing High On Economy, Fed’s Help

We know this is a phony rally, but so does everyone else. We know this will probably end badly eventually, but so does everyone else. The market likes to fool as many as possible and it seems that overall further gains would befuddle the greater number. Excessive optimism was worked off by the February correction. Sentiment allows for further gains.”

The April 26, Sentiment Picture (chart below) noted that: “36% of advisors and newsletter writers polled by Investor’s Intelligence (II) are looking for a correction. Incidentally, that’s exactly what we are expecting. However, the market rarely fulfills the expectation of the masses. A bullish surprise is possible.”

Market is Getting Hot, But Correction Talk is Getting Old

The percentage of advisors waiting for a correction has since dropped to 26% and a widely featured Reuters article exclaimed that “Correction talk gets old as rally sails along.”

As the media, investors, and newsletter writers are starting to discount the odds for an upcoming correction, we should become more alert and less complacent.

More importantly, there’s been a notable shift in money flow indicators. Investors are now actually putting their money where their mouth is. This is significant. Why?

There is a tipping point where there are simply not enough buyers left to push prices higher. Where is that tipping point?

The brand new Sentiment Picture for May (published by the Profit Radar Report) shows exactly how close various sentiment and money flow indicators are to their tipping point.