In 2004, Smarty Jones lost in the Belmont Stakes and failed to capture the Triple Crown.  Yesterday, California Chrome was also unsuccessful in its bid for immortality as the odds on favorite (i.e., “a sure thing”) turned in a less than spectacular performance.  10 years ago, I wrote an article on Smarty Jones and investor sentiment, and with so many people expecting so much from one horse, I wondered was it even worth your time to bet on such “a sure thing”.  After all, Smarty Jones, like California Chrome, was the heavy pre-race favorite and expected to pay less than $2 for a $2 bet.  In other words, why even bet when the payout was so low?

So this brings us to our current market environment, which has morphed into “a sure thing”.  The $VIX  has a 10 handle, and it is at yearly lows; all this suggests that investors are very complacent.  The “smart money”, which was modestly bullish a couple of weeks ago, has turned modestly bearish; the “dumb money” is headed to being extremely bullish.  All this points to the fact that investors are beginning to believe that this market is “a sure thing”.  From our perspective, betting on “a sure thing” really isn’t all that fruitful.  Yet, my dislike for betting on the “sure thing” isn’t so much that I have a belief that all “sure things” must fail, but rather why even play when the pay off on the “sure bet” is so small.

Contrarian investing is not about going against the consensus for the sake of going against the consensus.  This is more about understanding when to bet and when not.  I would view today’s certain market outlook (i.e., “a sure thing”) as a lousy time to go all in.  At these levels of investor sentiment, it is likely (~80% chance) that you will have an opportunity to buy at lower prices.  The other 20% of the time, when the markets trend higher as opposed to mean revert, are generally associated with accelerating economic growth, which is usually seen after a prolong downturn.

8 weeks ago, our “dumb money” indicator (see figure 1 below) dipped its toe into the extreme pessimism range after the markets (i.e., SP500) sold off only modestly (<5%). Since that single week extreme reading which was not a buy signal by our measures, the SP500 is up nearly 4%. The pullback on the way down wasn’t horrific by any means, and consequently, the bounce back shouldn’t occur with any great alacrity. But here we are with the SP500 notching new highs nearly everyday. Despite this we are still inclined to call this a NEUTRAL market environment, where the highs should be sold and where the dips should be bought.  For the prior 8 weeks and despite our lack of a buy signal, the sentiment indicators had a bullish skew, which would put a floor under this market.  As we come into this week, the sentiment indicators are starting to look a lot more bearish in aggregate.  They are not extremes yet, but I am sure investors will push the indicators to extreme levels.  Market highs will likely be sold.

In summary, “a sure thing” doesn’t always pan out, but betting on “a sure thing” generally is not worth the trouble.

And finally, I can’t believe I have been doing this for 10 years!!

Dumb Money/ Smart Money

The “Dumb Money” indicator (see figure 1) 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 1. The “Dumb Money”

Figure 2 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, moving from a Slight Buy Bias to Neutral. Trending suggests that sentiment could rapidly move into Sell Bias territory. The shifting sentiment is most pronounced within the Russell 2000, and within the Technology and Financial sectors. Excluding Financials, this past week, the number of buyers fell -33% from a week earlier while the number of non-10b5-1 sellers increased more than 50%. Meanwhile, the number of 10b5-1 trigger price Unusual Events is increasing as the S&P 500 continues to mark out new all-time highs and the NASDAQ Composite sits at its best levels since early April. It’s harder to sustain buying momentum because insiders don’t have unlimited funds and, behaviorally, we know that most insiders transact one-and-done buys instead of multiple buys. Nonetheless, we think the slowdown in buying should be viewed as a negative data point because it comes amidst an increase in selling.”

Figure 2. InsiderScore “Entire Market” value/ weekly

$VIX

Figure 3 is a weekly chart of the SP500 with the $VIX data in the lower panel. The black dots on the $VIX data are key pivot points, which are areas of support and resistance. The $VIX has closed at 10.73, and this is a multi-year low. Resistance is at a $VIX level of 12.22. Multi-year lows in the $VIX late in bull market cycles tend to be signs of complacency. Based upon this, we should expect selling in prices in the near future. See this Weekly Sentiment Report.

Figure 3. $VIX/ weekly