April 7, 2010, 7:20am EST   

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Wednesday's Need-To-Know  

Smart / Dumb Money Confidence


* Yesterday's push finally moved some of our short-term guides back to excessive optimism territory, including the STEM.MR Models, for the first time in nearly a month.  That suggests choppy price action ahead, at best.


* The move over the past few days has also moved the Smart Money / Dumb Money Confidence measures to their widest extreme in three years.  Historically, any further short-term gains were given back in the intermediate-term when that's been the case.


* For the long-term, one good sign is a lack of interest from penny stock traders, who continue to mostly ignore those lottery tickets.



The Dumb Money is 71% confident in a rally.

The Smart Money is 29% confident in a rally.


Smart/Dumb Confidence

View longer history



Short-term Outlook:  Neutral  From Feb 26, 1107 SPX



What:  We will remain Neutral for now.


Why:  The first two days of the week did their part in continuing the pattern we've seen so far this year.  As we looked at yesterday, though, the last three days of the week have been the weakest of the bunch (by far), so if the pattern holds then the bears might finally have a little seasonal wind at their backs.  Yesterday's push higher triggered a few more extremes on both a short-term and intermediate-term basis (see below).  Short-term, the STEM.MR models are finally overbought again for the first time in nearly a month (they're designed to make it harder and harder to become overbought during strong uptrends).  That suggests that we should see a period of choppy price action, at best, with any further pushes not being sustained.  That's the case on an intermediate-term basis as well.  Combined with a potential seasonal letdown, it makes sense that any early push to the widely-watched 1200 level would get pushed back in the days ahead, if we even manage to get there.  It's still way too early to suggest we're about to see an end to the raging momentum, much less an important peak, but we finally do have some solid signs that we likely won't go up every day from here.


Current S&P futures:  -3 points at 1183 



A solid chorus of extremes.

Short-term uptrend.

Sup / Res:


R: 1200-1225; S: 1150

Positive seasonality is running out.



Intermediate-term Outlook:  Neutral  From Feb 2, 1104 SPX



What:  We will remain Neutral for now.


Why:  In early January, the Dumb Money Confidence hit 75%, which was another successful "protect your gains" warning sign.  By early February, we went over several studies suggesting we were very close to a good multi-week buy signal, but they just missed triggering.  In the process, there have been some more encouraging signs (such as no overwhelming number of signs that we have seen a major market peak, the advance/decline line at a new all-time high and extreme momentum in small-cap stocks).  The spread between the Smart Money and Dumb Money just moved beyond -40%, the largest negative spread since early 2007, so there are some definite intermediate-term warning signs.  Every time we've seen this, any further short-term gains were eventually erased, and we feel that's likely this time too.  But timing the end of the advance is fraught with risk, so we have to wait for some sign that the momentum is waning...or see a monumental spike in speculative activity that would indicate a blow-off peak.  We don't have either just yet.




Very overbought

Still pointing up.

Sup / Res:


R: 1200-1225; S: 1110

Positive breadth, small-cap momentum



Equity Indicators - Updates and Extremes


Smart / Dumb Money Confidence


Near the February low, the indicators that make up our Dumb Money Confidence had retreated enough to push it down to 41%.  That's not quite extreme territory, but certainly more encouraging than the 75% it had reached in January.


During the rally since then, we saw a couple of stretches where the Dumb Money didn't move at all for days (even weeks) on end.  That changed during mid-March when it spiked above 70%, then it dipped and went flat again.


We've now seen another push above 70%, and depending on how the next couple of days ago, it could reach 75%-79% by the end of the week.  That would be a definite, and imminent, danger sign.  Especially with the Smart Money below 30%.


Already, we're seeing an unusual situation with both measures at opposite extremes.  This is only the sixth time in 15 years that the Smart Money has been under 30% and the Dumb Money above 70% at the same time.



Here's how the S&P 500 fared going forward when we've seen this combination in the past.



1 Week


1 Month


3 Months


Max Gain

Before Correction

07/29/97 1.0% -3.5% -7.7% 2.3%
08/24/00 0.4% -3.6% -12.7% 1.2%
06/18/03 -3.7% -1.9% 1.8% 0.5%
11/12/04 -0.9% 1.8% 2.0% 3.2%
12/13/06 1.5% 1.7% 0.1% 3.4%
Average -0.3% -1.1% -3.3% 2.1%


The results aren't disastrous (excepting the August 2000 occurrence), but the theme is that any further short-term gains were erased every time.  The S&P did manage to tack on an average of another +2% or so before rolling over, but each time it did fall back before (maybe) resuming its uptrend.


Because of that, the risk/reward profile over the intermediate-term of three months was not positive.  The average maximum decline during that span was -6.1% compared to an average maximum rally of +3.0%.  In each instance but one (November 2004), the max decline over the next three months outweighed the max gain.


This is consistent with several other indicators we've looked at lately - stocks may continue the unrelenting push, but it's a game of a musical chairs, and when the music stops the one left standing will likely fall hard.



OTC (Pink Sheet) Volume


One of my favorite guides for determining the level of long-term speculative flows is the eagerness of penny stock traders to ply their craft.  When we see traders of the lowest-of-the-low start to get excited about trading what are essentially just lottery tickets, then we know we're headed for trouble.


We've looked at this a few times over the past nine months or so, and none of those times were we able to determine that there was speculative excess entering the market.  From a long-term perspective, these traders were behaving in a pretty muted fashion.


That still hasn't changed.



Given some of the other sentiment measures we follow, such as from the options market, I thought there was a good chance we would have seen penny stock volume explode higher during March.  But it didn't happen.


There was an increase across all metrics (share volume, dollar volume and turnover), but it was relatively minor and still below the fall 2009 highs - much less the 2006 highs.


I suppose if we really want to search for something that might be troubling, we could point out the year-over-year change in dollar volume.  Since it had sunk so low in early 2009 (which seemed like a good reason at the time to expect an important market bottom), the yearly change has mushroomed to 240% (i.e. dollar volume is more than three times higher now than it was in March 2009).


There have been two other times we've seen the year-over-year change spike higher:



The first one pretty much marked the peak of the technology hysteria in 2000.  The other was a situation more similar to now in the recovery from the 2002 bottom.  The Nasdaq Composite did manage to tack on another few months of gains afterward, though those were eventually given back during the first half of 2004.


I'm not too concerned about this, simply because we're coming off such a low base from 2009.  I would be much more worried from a long-term perspective if we suddenly see a big spike in volume in these stocks, and so far we're just not getting it.


Equity Market Indicators



During the volatile correction into early February, we saw a spike in our Bullish (for the market) indicators to 30%, and the Bearish very nearly reached 0%.  That coincided with the low in equities.


The rebound since then was met with mostly mediocre readings in our indicators.  A couple of weeks ago we got a spike in bearish indicators without much subsequent negative impact in stocks, and we're once again at that extreme, with more than 30% bearish.  Since the March 2009 low, this combination has consistently led to short-term corrections.


More history:   Short-term Score     Long-term Score    Indicators At Extremes



* New extreme

See all indicators


Bonds, Commodities and Currencies - Updates and Extremes


Nothing notable for today.



Jason Goepfert

Founder, Sundial Capital Research, Inc.



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