In an interesting and sudden turn, the “smart money” has turned bearish.

I say “interesting and sudden” because our “smart money” indicator (see figure 3 below) was quasi bullish just a week ago and this past week, the numbers are coming in bearish. Furthermore, equity prices (i.e., SP500) were fairly flat for the week putting a degree of caution into the data. Typically, the “smart money” will be sellers as prices rise, so it is reasonable to ask why were insiders selling when prices weren’t up?

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So how should we interpret this going forward? From my perspective, this is bearish. Higher equity prices will bring in greater number of insiders selling their shares, and this will push the indicator to an even more extreme level. This is a headwind we shouldn’t ignore. In essence, if company insiders are selling their shares presumably because the prospects for the underlying business don’t support the valuations, then why should you be buying them?

Ahh, but do what you want.

Over here at TacticalBeta, we have been NEUTRAL on the equity markets for 2 weeks now. Our equity model turned bearish 2 weeks ago, yet the technicals remain constructive. We sold our equity positions 2 weeks ago, but we recognize we are in a NEUTRAL investing environment that historically (i.e., 23 years of data) has had little edge. However, over the past 2 years such environments have been kind to investors as QE announcements and Fed jawboning have seem to come during these periods after the bullish market mojo has fallen, but prior to a sell off in prices. This is just another way of saying that the dips have been shallow as investors have learned to anticipate Fed intervention and that the equity markets really haven’t sold off for quite some time. I don’t believe this is healthy bull market action, and I am sure that I am in the minority opinion on this one, but then again, I don’t whine or angst on every 2-3% correction.

Let’s return to our NEUTRAL investing environment. So what does it mean? One, it defines a market environment where the SP500 has underperformed over the entirety of the data, and there is no predictable edge to the price action. Two, the price action tends to be ruled by overbought and oversold signals. Three, it gives investors an opportunity to reduce – -as opposed to being all in or all out like a light switch — their allocation to equities. With little predictive edge, why be in the markets full throttle? Look at investing this way. You are a card counting black jack player. You cannot predict the next winning hand or cards that come out of the shoe, but you can determine (and this is the sole purpose of card counting) when is the best time to bet heavy. A neutral market environment may or may not produce a winning trade, but it is not a time to be betting heavy. Got it?

To summarize, the “smart money” indicator has turned bearish. This is more in alignment with the other sentiment indicators, which have been showing too many bulls for quite some time. These indicators, like the “dumb money” (figure 2 below) and the Rydex data (not shown), have been un-winding for several weeks now. Higher prices should see more corporate insiders selling, and this is a headwind.

The Sentimeter

Figure 1 is our composite sentiment indicator. This is the data behind the “Sentimeter”. This is our most comprehensive equity market sentiment indicator, and it is constructed from 10 different variables that assess investor sentiment and behavior. It utilizes opinion data (i.e., Investors Intelligence) as well as asset data and money flows (i.e., Rydex and insider buying). The indicator goes back to 2004. (Editor’s note: Subscribers to the TacticalBeta Gold Service have this data available for download.) This composite sentiment indicator moved to its most extreme position 10 weeks ago, and prior extremes since the 2009 are noted with the pink vertical bars. The March, 2010, February, 2011, and February, 2012 signals were spot on — warning of a market top. The November, 2010 and December, 2012 signals were failures in the sense that prices continued significantly higher. The current reading is neutral.

Figure 1. The Sentimeter

Dumb Money/ Smart Money

The “Dumb Money” indicator (see figure 2) 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. The indicator shows that investors are NEUTRAL.

Figure 2. The “Dumb Money”

Figure 3 is a weekly chart of the SP500 with the InsiderScore “entire market” value in the lower panel. From the InsiderScore weekly report: “Market-wide sentiment has shifted demonstrably, moving from Neutral into Slight Sell Bias territory. This past week, there was a significant increase in the number of sellers while the number of buyers fell by more than -20%. The Healthcare sector is showing the weakest sentiment and two closely-watched industries — Transportation and Semiconductors — are showing very weak sentiment. Additionally, there’s been a slowdown in buying within the Banking industry.”

Figure 3. InsiderScore “Entire Market” value/ weekly