Introduction

I saw this headline (or something to the effect) somewhere: “Number of Bullish Newsletter Writers Highest Since 2007 Top”.

Ahhh….run for the hills!

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The percentage of bullish newsletter writers in the Investors Intelligence sentiment poll now sits at 61.2. This is the highest value since October, 2007, which is exactly 1 week after the SP500 peaked and then went on to drop over 50% in the next 18 months. There must be some meaning to this number. Right?

However, as I showed in the article, “Weekly Sentiment Report: A Noteworthy Extreme (This Is Not What You Think)”, such extremes in the sentiment data are just that– extremes in the data. So while greater than 60% bullish newsletter writers was seen at the 2007 top, this number was also seen throughout the history of the data series and the market did not fall apart or find itself in a bear market over the next year. See figure 1 of examples over the past 15 years. In fact, having lots of bulls, like having extremes in the number of bears, generally does not imply what you think. Certainly, I would not run for the hills based upon 1 number.

Figure 1. % Bullish Newsletter Writers/ weekly

But this should not imply a green light or an “all clear” signal either. From our perspective, I would rather be a buyer (as the data supports) when investors are bearish, and I would rather be a seller when they are bullish. At this point in the price cycle, the trend of prices should begin to flatten out. Rather than being a seller at some extreme point, we typically wait until investor sentiment unwinds. More specifically, we will sell our equity positions 1 week after the “dumb money” indicator crosses below the upper trading band. See figure 4 (below) for details.

The extremes in bullish sentiment that we are currently seeing really suggest that we are late in the current price move. Furthermore, I can certainly state that there are issues under the surface. One issue is the willingness of investors to buy the dip on shorter and shorter time frames. In essence, a market that doesn’t periodically clear itself of the weak hands (i.e., a big, nasty sell off) is a market built on a weak foundation. A second issue is the negative divergence that we are seeing between the $VIX and the SP500. As prices go higher, we should expect the $VIX to move lower, but the $VIX has been unable to break below a level of 12 over the past 12 months despite the near 30% gain in the SP500. As figure 2 below shows, selling has occurred when the $VIX tags the 12 level, but from a big picture perspective, the $VIX has failed to confirm the price move in the SP500. Furthermore, a weekly close above 14.64 on the $VIX would highly suggest a deeper and prolonged sell off in prices. I discussed the implications of support and resistance in the $VIX in this video back in September, 2013.

Figure 2. $VIX/ weekly

Our equity model, which is built around the “dumb money” indicator (see figure 4 below), remains bullish, and will likely remain so for another 2 weeks or more. This current trade has gone on for 17 weeks now when we became bullish during a period of extreme investor bearishness, and it is our expectation that this trade should last on average 15 weeks. The best, most accelerated gains typically occur in the beginning of the trade. Just when investors typically get the all clear, the trend will flatten out. Our plan is to become sellers of equities when investor sentiment unwinds, but we are not at that point. As a reminder, we have moved our stop loss up to SP500 1706.92.

In the final analysis, there are reasons for concern as investors have become and remain extremely bullish. Would I run for the hills? Not yet, but with every passing week, we are getting closer to that point. That’s the conundrum investors must face if they want in to this market now.

The Sentimeter

Figure 3 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 but heading towards bearish (as in too many bullish investors).

Figure 3. The Sentimeter

Dumb Money/ Smart Money

The “Dumb Money” indicator (see figure 4) 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 extremely bullish.

Figure 4. The “Dumb Money”

F
igure 5 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 continues to move further into Neutral territory, away from a Sell Bias, as transactional volume begins a seasonal decline. With earnings season beginning in two weeks, most companies have closed trading windows, limiting the ability of insiders to transact non-10b5-1 purchases and sales. “

Figure 5. InsiderScore “Entire Market” value/ weekly