Introduction

Last week's "Mixed Signals" seems to be reflective of the narrow 4 week trading range that the market now finds itself in. But clues to market direction are surfacing.

What are those clues? The first is the $VIX. See figure 1 a weekly chart of the SP500 with the $VIX in the lower panel. The black dots over the $VIX data are key pivot points that define support and resistance areas. A break of support in the $VIX should be accompanied by higher prices in the index. Conversely, a break above of a resistance level should be consistent with lower equity prices. For the past year, the $VIX has been unable to break below the 12 level. The failure of the $VIX to close decisively below the 12 level and confirm the price action, which has been moving higher, is a noteworthy negative divergence that remains uncorrected.

Figure 1. $VIX/ weekly

A more important tell has been the recent price action in the $VIX. A week ago, the $VIX did close below the most recent key pivot point level at 12.22, but this break down was quickly reversed as the $VIX is now at 12.44 and back above the key pivot point level. See figure 1 above. Such reversals --i.e., below a key pivot point and immediately back above again -- in the $VIX should be watched carefully. Looking at figure 2 below, the red dots over the SP500 price bars are those times that the $VIX reversed from below a key pivot point to back above. Such action in the $VIX has marked every top/ pullback of significance in the past 2 years.

Figure 2. $VIX/ weekly

Another clue comes from the Rydex market timer. See figure 3 below, which is a weekly chart of the SP500 with the Rydex Total Bull to Total Bear ratio in the lower panel. If there is one group of market timers who actually have timed this market well over the past 4 years, it has been (oddly enough) the Rydex market timers. The indicator is rolling over, which is a sign that these market timers are becoming less bullish. As figure 3 shows, crosses of the indicator below the signal line (at a high value) have been consistent with a market top over the past 2 years.

Figure 3. Rydex Total Bull/ Bear

So what should we do? In my opinion, these clues are a sign of being late in the rally. They should be respected. Should it be another "run for the hills the market is going to crash kind of moment"? The answer to that question I don't know. From my perspective, I refer to our equity model, which is based upon the "dumb money" indicator (shown in figure 5). The model remains bullish, and will likely remain so for another 2 weeks or more. Exit signals typically occur a week or 2 after investor sentiment has unwound. In essence, we are selling to those investors late to the rally and whom are buying the initial dip after investor sentiment has unwound. The clues cited above are early signs of investor sentiment unraveling. At these levels of bullish sentiment, fewer bulls isn't a contrarian signal but a sign that there are fewer investors willing to push the market higher.

We have been bullish for 19 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. So we are in the late stages of the rally. 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. (Does this sound familiar?) As a reminder, we have moved our stop loss up to SP500 1706.92.

The Sentimeter

Figure 4 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 4. The Sentimeter

Dumb Money/ Smart Money

The “Dumb Money” indicator (see figure 5) 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 5. The "Dumb Money"

Figure 6 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 continues a seasonal decline. With earnings season beginning shortly, most companies have closed trading windows, limiting the ability of insiders to transact non-10b5-1 purchases and sales. "

Figure 6. InsiderScore “Entire Market” value/ weekly

Rydex Asset Data

Figure 7 is a weekly chart of the SP500. The indicator in the lower panel measures all the assets in the Rydex bullish oriented equity funds divided by the sum of assets in the bullish oriented equity funds plus the assets in the bearish oriented equity funds. When the indicator is green, the value is low and there is fear in the market; this is where market bottoms are forged. When the indicator is red, there is complacency in the market. There are too many bulls and this is when market advances stall. Currently, the value of the indicator is 78.35%. The indicator is crossing below the signal line.  Values less than 50% are associated with market bottoms. Values greater than 58% are associated with market tops. It should be noted that the market topped out in 2011 and 2012 with this indicator between 70% and 72%.

Figure 7. Rydex Total Bull v. Total Bear/ weekly

The Rydex Buying Power indicator assesses the amount of money on the sidelines. It is “fuel” available for buying. This indicator assesses both non – committed money (i.e., assets in the money market fund) and committed money (i.e., assets in all of the bearish funds that could potentially wind up in bullish funds) as available money on the sidelines. Low indicator values suggest little money on the sidelines and are consistent with excessive bullishness (i.e., bear signals). High indicator values are consistent with increased buying power and are consistent excessive bearishness (i.e., bull signals). The current value of the indicator is at 33.83%. Values less than 40% are consistent with market tops.

Figure 8. Rydex Buying Power/ weekly

$VIX

Figure 8 is a weekly chart of the SP500. The indicator in the lower panel looks at the current value of the $VIX relative to past pivot points in the $VIX and trend lines formed by those pivot points. The indicator is turning higher suggesting that price should be moving higher.  As we wrote last week, this is one of those “mixed signals” as the indicator is at odds with the raw data.   

Figure 8. $VIX/ weekly

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