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Dumb Money Confidence...Some Good News (And Some Bad)

02/27/09 8:55 AM EST


As of:


SPX 746



Good Friday morning...We begin the day with heavy selling pressure as we finally get some resolution regarding Citigroup, which is being cut almost in half during the pre-market.  In response, the S&P 500 is indicating yet another 2% down open, the third time in two weeks (the only other time we've seen that kind of a cluster was October 10th of last year).


Ever since mid-January, I've been pounding out the same drumbeat on an intermediate-term time frame - because of January's failure to follow through on several bullish studies generated in late November / early December, we either needed to see a substantial pessimistic extreme in Dumb Money Confidence, or a much-improved technical picture in order to help support any multi-week (at least) long positions.


Both conditions have been a non-starter.  Technically, we have not been able to sustain any progress that would improve the outlook, first failing to overcome 875 a couple of weeks ago and then just yesterday not being able to get over 780 which would have triggered a positive short-term pattern.


As far as the Dumb Money Confidence, we've been out of luck there too.  Now, finally, we have some good news on that front...but I'm afraid it's tempered by a bit of bad news too.  We'll get to that a little later.


First, the chart:



Yesterday's steady downtrend helped drop the Confidence level another degree, dragging it down to 21%.  This is the most pessimistic reading from that guide since the November bottom, and it's obviously a welcome change from the 67% reading in early January.


The good news is that when we've seen this kind of extreme during the past two bear markets, we've been at or very near an inflection point in the broader market.  The table below shows each date when the Dumb Money first touched or exceeded 21%, after having been above that level the day prior.


I've left out a few dates when we chopped back and forth above that level, which would have actually helped the results quite a bit - I'm not interested in just showing positive numbers, I want to help us flesh out the risk/reward when the Dumb Money first drops to such an extreme.


S&P 500 Performance When

Dumb Money First Crosses Below 21%


Days To






09/17/2001 4 -10.1% 5.5%
07/22/2002 1 -5.5% 14.8%
09/20/2002 13 -8.6% 6.9%
02/10/2003 3 -5.5% -3.5%
03/03/2003 6 -5.6% 2.3%
03/10/2008 0 -1.6% 6.1%
06/30/2008 10 -6.2% 0.4%
10/07/2008 3 -16.5% -3.8%
11/20/2008 0 -1.7% 15.4%
Average 4 -6.4% +4.9%


On average, it took the S&P another 4 days before bottoming.  On three occurrences, it marked either the low day or within one session of it, and on three others it occurred within 4 trading days.  So two-thirds of the time we saw a bottom within one week.


Two of them were more involved, where we saw several false starts, but within three weeks a low was established and even with those drawn-out instances the worst loss wasn't much worse than the others that established a low sooner.


The risk of a temporary spike lower is quite high, however.  The average drawdown (i.e. maximum loss) before bottoming was a hefty -6.4%, with two of them being more than -10%.  With stock exposure of 10% or so, a 10% drawdown isn't that bad, but it makes it difficult to want to commit a lot more unless/until we see those final "puke" session(s).


That's where the bad news comes in.


A couple of the components of the Dumb Money, most egregiously the put/call ratios, are not near the kinds of levels that will help push the Confidence lower.  So this 21% reading we have today is probably the lowest it's going to go, unless we get really ugly for a one to two more weeks.  We could maybe get to 17% within another couple of days, but not to the 13% that marked the last two panic lows for another week at the very least.


Same goes for the Smart Money Confidence.  We could get to 63% within a day or two, but to get to 70% or higher it would almost certainly take one more week at the very least.


Bottom line - Intermediate-term


We went over several studies in December (here and here and here) indicating that what we witnessed during November marked a major bottom.  But after what we went through to begin the New Year (e.g. the spike in Dumb Money Confidence and Intermediate-term Indicator Score, the failed breakout at 920 on the S&P, the subsequent losses of support at 880 and 850, and the failure to bounce off short-term oversold conditions), that probability diminished substantially.


Because of that January failure, I had been leery of buying into weakness until we either saw more of a pessimistic extreme in the Dumb Money, or an improved technical picture.  The Dumb Money is getting there with a current reading of 21% as we discussed above, but that still doesn't quite match the previous pessimistic extremes under 17% that we saw at each of the prior temporary lows since 2007.


As for the technical picture, the S&P 500 broke under the 800 area that had been support, and it's now hanging by a thread at the November lows.  Ironically, probably the best thing we can do to establish an intermediate-term low sooner rather than later is to break that 740 level and see some intense short-term selling pressure.


Given the AAII data mentioned last week , a few other potential positives (now including the 90% Up Volume session from Tuesday), and the current Dumb Money Confidence reading of 21%, I'm confident that we will witness another multi-week (and possibly multi-month) low by mid-March.  Buying now will probably still lead to a positive return in that time frame, but the intra-trade drawdown could be "uncomfortable" if heavily invested.


From this point, I am going to be looking to add long positions on an intermediate-term time frame instead of just short-term trades, but not just yet.  If we hit 725ish today or Monday, I'll likely add the first tranche (of four), with the second on a move to 675ish.  I may become more or less aggressive depending on how the sentiment readings look at the time, but that's the plan at the moment.


Bottom line - Short-term


On Tuesday morning we went over several reasons to expect positive returns over the coming week.  After the big rally on Tuesday, we discussed a few more reasons to expect another 2 to 4 days of upside follow-through.


Yesterday I showed a chart that laid out my preferred scenario to help trigger that additional upside.  In order to trip that trigger, we needed to take out 780ish area on the S&P and make a higher high after the first hour of trading given the size of the gap up opening.  Buying interest wasn't enough to do either, now we're looking at yet another bullish pattern failure.


As I mentioned above, I'm getting significantly more optimistic on an intermediate-term time frame, and I think the chances are better than, say, 60% that we'll be trading higher than these levels several weeks from now, even if we violate the November lows in the coming sessions.


But the short-term path to get there is fraught with risk and volatility.  I don't see much at all on a short-term time frame among our sentiment guides that would have me sticking my neck out on the long side, especially if we break 740 on the S&P.  That leaves an air pocket underneath, but when we gap down this large, and under a previous low, the market has a consistent tendency to snap back, so there is extreme risk this morning from both the long and short side.  About the best risk/reward short-term trade I see from here would be a gap under 740 that's then re-taken during the day, with a stop under the day's low just in case.


All the best,


Jason Goepfert

President and CEO

Sundial Capital Research, Inc.



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