Slowly falling into place

We are seeing more clarity on the sentiment and psychology side of the market.  It has been a long strange trip this year with investors being overly nervous while the market was climbing.  That is just plain unusual.  Last week I pointed out that we are finally starting to see that nervousness being lifted.  It's not quite to extreme levels but its getting closer.

Since we are always picking up new readers here at TSP Talk, let me go over the confusing explanation of how sentiment is a contrarian indicator - that is, good means bad, and bad means good. 

As you probably know a bull is someone who believes the market is going to go higher.  A bear believes it is going to move lower.  What happens to the market when we get an extreme percentage of bulls or bears?  It tends to go against any large majority.

As an extreme example, if 100% of the investors asked said they were bullish, it sounds good for the market, right?  Actually, it's not.  If 100% are bullish, that means that investors are probably fully invested already and do not have a lot of cash on hand.  So who is left to buy?  No one.  And that's why if an extreme number of investors are bullish, the more likely it is that the market is closer to a top than a bottom. 

The same of course is true for extreme bearish readings.  Too many bears and the market is likely to go up.  The bears would have a lot of cash on hand as they have been selling all along.  Now all they can do is nothing, or buy.  That's why the market would likely go up.  Confusing, I know.

In Friday's comments I displayed the current AAII Investor Sentiment Survey results and at 44% bulls, 26% bears, we are not quite at an extreme, but it's getting closer to the 2 to 1 ratio that would be a red flag.

On our own TSP Talk Survey that we do each weekend we have the bulls at 49% and the bears 29%.

I reference the SentimenTrader.com website quite often here because I am a big fan of what they have to offer those who watch the psychology of the market.  They have many indicators that they use and they come up with an accumulation of all of the indicators and assign a "score" for what the smart money, and the dumb money are doing. 

The smart money indicators are based on what the more experienced, sophisticated, professional investors are doing.    When that smart money score hits 60% or higher it is a good sign for the market.  When it gets to 40% or lower it is a warning sign.  The current smart money score is 38%

The dumb money is basically the rest of us.  The dumb money signals are the opposite of the smart money's.  When the dumb money score moves to 40% or lower, it is a good sign for the market.  When it hits 60% or more, it is a warning sign.  The dumb money score is currently 57%.

  
                             Chart provided courtesy of www.sentimentrader.com

When both the smart money score is 60% or higher and the dumb money score is 40% or lower, it is a pretty good buy signal.

When both the smart money score is 40% or lower and the dumb money is 60% or higher it is a pretty good sell signal.

The smart money is now below 40% for the first time since January 2004.  Since that chart didn't show us any sell signals, I marked two of the strong buy signals we've seen in the past year.  You can see the dumb money was the most bearish near the market bottoms while the smart money was buying away.

None of this is a sure thing but if the market does fall from here, it shouldn't come as a surprise as I look at sentiment and psychology as some of the strongest market indicators we have.  I missed the November rally but it wasn't because the psychology indicators weren't accurate.  They were dead on.  It was me acting like the "dumb money" out of fear.  Here we are on the other end.  We are seeing the signs of a reason to be nervous, because the dumb money is getting less and less nervous.  Get it?

The Fed meeting is Tuesday of this week and the odds are we get another interest rate hike.  The hike itself shouldn't move the market but rather what is said about possible future rate hikes. 

That's all for today.  Currently 100% G fund.  It should be a fun week.  Thanks for reading. 
 

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