Leading indicators suggest correction approaching

February 23, 20151 Comment

While you and I should watch market trends (peak & trough movements) as our ultimate decision making tool, there are a few leading indicators that technical analysts should be watching as clues to the future. One such tool is sentiment. Below is a chart, courtesy of www.sentimentrader.com, illustrating the ratio of smart money vs. dumb money. Smart Money, for those who have not followed this blog for long, represents those traders who are usually accurate in their decisions. Institutions, pensions, insiders, sophisticated traders – they tend to win the market timing game. Dumb Money investors are those who are bad market timers. Retail investors, small speculators, mutual fund investors—these are unsophisticated investors who buy and sell on emotion.

Smart dumb $


The current spread is growing bearishly on this indicator. Currently, 75% of Dumb Money is bullish—up from about 55% just a couple of months ago. Meanwhile, Smart money is getting out of the market. That group has gone from 65% bullish to 50% bullish as of Friday. The 15 year chart above shows the spread between these groups—and it’s just under the “excessive optimism”point (by the dumb folks – yellow bars indicate historic occurrences). You will note on the chart that levels can get a bit further over the sell line before rounding down—so there is likely a bit more time to go before the market reaches a peak. Seasonality studies would agree with that thought process.

On a similar note, a related sentiment indicator by CNN called the “Fear and Greed” indicator is reading 80 on a scale of 0-100 (chart not shown). Typically this indicator is accurate as a sell signal the number gets closer to 100. Conversely, the closer to “0”, the better the markets forward prospects. The current CNN indicators reading suggests a bit more time to go, but it is getting closer to a sell signal.

The next chart – below – is courtesy of Robert Shiller, as printed in a report by ACG Analytics. It shows us the # of consecutive positive years the market has made before a negative year sets in. This data goes back to the late 1800’s so it’s a good data sample! You will note that, historically, most market runs last much less than 6 years. In fact, the current 6 year run is the only other 6-year run in history – the last one being in 1898.

# positive years


I’ve said it before, and will say it again. Whether you utilize technical indicators or fundamental valuations for your market timing – or tea leaves for that matter—common sense tells us that we are overdue a correction. The Shiller chart helps clarify the difficulty that markets will have in pulling off another positive year in 2015 – making it a 7 year run. In fact, it would be an historic event.

I remain long the market at this time, with a finger hovering over the sell button.


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