The arti­cle below is a guest con­tri­bu­tion by Guy Lerner, writer of the Tech­ni­cal Take blog.

Most mar­ket par­tic­i­pants use investor sen­ti­ment as a con­trary tool. Gauge which direc­tion the major­ity of investors are lean­ing and bet against them. But there are times when it doesn’t pay to bet against the herd. There are times when too many bulls is a good thing as in “it takes bulls to make a bull mar­ket”. So here we have the SP500 clos­ing above the much watched 40 week mov­ing aver­age, and I am sure many an investor is try­ing to gauge the sig­nif­i­cance of such a mile­stone in this sea­son­ally pos­i­tive time of year when trad­ing vol­umes have shrunk. So this tech­ni­cal event must mean something?

Yes, it means that the SP500 has now been above the 40 week mov­ing aver­age only twice in the past 20 weeks. Does it mean that the mar­ket is on the cusp of an explo­sive move higher? If the mar­ket is, don’t tell investors because they haven’t got­ten the mes­sage yet. And that is really the trou­ble with this mar­ket – there are nei­ther bears or bulls out there. If the mar­ket is really going to move higher in a mean­ing­ful way, I would think that we would begin to see the “it takes bulls to make a bull mar­ket” sce­nario (i.e, too many bulls) unfold as prices move higher. This is how new trends start, but instead we are just see­ing ehhh.

So if this price move is for real and if the pend­ing reces­sion (see here) is going to be thwarted, then I would expect to see buy­ers. Sen­ti­ment cuts both ways some­times; hav­ing a lot of bulls could be a good thing. For now, I remain bear­ish, and I gave my rea­sons nearly 4 weeks ago. Despite the pass­ing of time and the expected hol­i­day rally, lit­tle has hap­pened to change that opinion.

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. This indi­ca­tor shows neu­tral sentiment.

Fig­ure 1. “Dumb Money”/ weekly

Fig­ure 2 is a weekly chart of the SP500 with the Insid­er­Score “entire mar­ket” value in the lower panel. From the Insid­er­Score weekly report: “As of 12/21/11 – Sen­ti­ment moved from a Sell Bias to Neu­tral as buy­ers out­num­bered sell­ers – albeit by the slimmest of mar­gins – for the first time in three weeks. The main sen­ti­ment dri­ver was a decrease in sell­ing, as the num­ber of sell­ers fell nearly –23% week-over-week ver­sus a 7% increase in the num­ber of buy­ers. The Con­sumer Dis­cre­tionary and Energy sec­tors showed the great­est improve­ment in sen­ti­ment, with a drop in sell­ing again being the main cause. There con­tin­ues to be a fair amount of action­able buy­ing and action­able sell­ing and with no sec­tor show­ing a par­tic­u­larly strong sig­nal in either direc­tion we find company-level activ­ity most compelling.”

Fig­ure 2. Insid­er­Score “Entire Mar­ket” value/ weekly

Fig­ure 3 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 58.72%. Val­ues less than 50% are asso­ci­ated with mar­ket bot­toms. Val­ues greater than 58% are asso­ci­ated with mar­ket tops.

Fig­ure 3. Rydex Total Bull v. Total Bear/ weekly

Let me also remind read­ers that we are offer­ing a one-month free trial to our Daily Sen­ti­ment Report, which focuses on daily mar­ket sen­ti­ment and the Rydex asset data. This is excel­lent data based upon real assets and not opinions.

Source: Guy Lerner, Tech­ni­cal Take, Decem­ber 25, 2011.

Read more from the author/contributor here.

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