Hello, and welcome to the Smart Money, Dumb Money show. And I am your host, Keith Richards, I’m president and chief portfolio manager of ValueTrend Wealth Management. And today we’re going to talk about a couple of sentiment indicators that you can access at no cost on the internet. I wrote a book as some of you may be aware of called Smart Money, Dumb Money. Good looking guy on the cover here, walking across the road like the Abbey Road scene. And in this book, I list somewhere between 15 and 20 indicators. Actually I have never stopped and counted the number of indicators I talked about in this book, but there’s quite a few sentiment indicators. A lot of the indicators I talk about you have to have a subscription to stockcharts.com or TC2000 charting or one of these subscription type charting softwares. And I also quote a number of sentiment surveys that come out of my favorite sentiment website, which is called sentimentrader.com.
Now those are both subscription services, so you have to pay to use them. But I do list a number of things that you can do for free if you want to learn about the relative optimism of the crowd, the herd. So I’m going to cover two of them today. And this kind of expands on an idea that I presented on one of my blogs last week, and that blog covered the American Association of Individual Investors and how they are looking at the market on a forward basis from a relative bull, bear or neutral basis. And the indicator that I covered in my blog was looking at the percentage of bears amongst their membership. So it was just looking at one side of their survey, which is the percentage of bears and effectively what the American Association of Individual Investors is, it’s a big organization.
It has many, many, many, many thousands of investors, all retail investors, ordinary people, and it shares great ideas with them. You too could become a member. I don’t think it costs much it’s but they survey the members on a monthly basis and they ask them, what’s your outlook. And what they’ve found is just like every sentiment indicator is when too many of their members. And it’s a pretty good sample survey size of how retail investors look at things when they find that too many of their investors are skewed towards a bullish or a bearish opinion that can give us accurate signals as far as market peaks and market troughs. So the indicator I looked at last week was just looking at the bears. And obviously, if you understand how sentiment indicators work, they’re contrarian indicators, and when there’s too many bears, that means that we’re probably at the bottom of the market and that’s actually what that indicator showed me.
But today we’re gonna look at the full AAII sentiment indicator, which you can access for free just by clicking on the website. You go to AAII.com and look for the survey, and then we’re gonna look at another free sentiment indicator by another big organization, CNN it’s the CNN Fear and Greed Index, and a game-day survey, a whole block of investors as to whether they’re fearful or not fearful. And too much exuberance, as you know, means that the market’s at a peak because you always need to climb that wall of worry, as they say. If there are no worries out there, it’s probably a sign of irrational exuberance as Greenspan once said. And if there’s too many bears, too much fear out there, then vice versa. I explain how these work in my book. I won’t bother getting into it on this video, but I would like to share the screen right now and show you these two indicators and you can access them for free.
And they’re actually pretty, pretty accurate when it comes to the extremes. And I’ll give you an idea of how to read them insofar as what percentages you want to see in terms of bulls and bears or fear and greed before you make any sentiment-orientated decisions on your investments. So let’s get right to work and we’ll share the screen. So here we go. This is the, I’ll start with the CNN Fear and Greed index. And you can see that if we go back a month ago, and any of you that watch these videos and read my blogs at ValueTrend.ca know that at the very beginning of January, I think it was January 3rd or January 4th, I posted a blog and I said, I think the market’s going to fall. And at the time the S&P was at 4,800 a little over that I think, and it subsequently fell by 500 points.
So I was right. Well, at that time, beginning of January, you can see that there was a whole bunch of greed. And that was one of the reasons, along with a technical price channel, that I was looking at. But that was one of the reasons why I felt the market would decline is because not just this indicator, but many indicators were showing excess optimism. So you can see, we went from a high level of greed, like 69, which is somewhere around here, very high on the greed to fear index in their survey, and guess where we are right now, we’re growing deeper and deeper in the fear. In fact, previously we were at 36 out of a hundred from fear to greed, and now it’s down to 33. So the fear is becoming greater on the market, according to this particular indicator.
So this is free. You go to CNN.com and you can actually type in CNN Fear and Greed Index, and you can watch this thing on a regular basis. So it’s a pretty good indicator though, that when this indicator gets into the red zone, particularly in that final quote, that you have a very strong buy signal and we’re pretty close. So let’s take a look then at the AAII indicator. And remember on my blog, I showed you the bears only. So this is the percentage of bearish people, and that is represented on this chart by the red bar. Neutral, there are always people that have no opinion or think everything is gonna be about the same. And that’s represented by gray and green is the percentage of bulls. Now, under normal circumstances, you have kind of a balance. You can see here, this is the historic average.
It’s not quite a third, a third, a third, but you do get a fairly good distribution with some bias towards optimism, bullishness. And that’s a long term historic index. And these guys have been doing this for as long as I can remember. I came into the business in 1990 and then I, seems to me I learned about this indicator just a few years after I got into the business. So it’s been around a long, long time, at least a quarter of a century. So that’s the historic average, but where were we back when I wrote my blog? Well, we had a recent reading of bearishness of 43% and a recent reading of bullish outlook of only 26% with about 30% neutral. Well, what I found and I pointed this out in my book, is that if you have less than a third, less than 33% of their survey members saying that the market outlook is bullish, then you have a high level of pessimism, and you’re looking at a probable turnaround in the market.
So that is exactly where we’ve been for a while, actually over the past couple of weeks as the market has been pretty nasty. And so it’s suggesting as well that the number of bulls are too low. And just a week ago, when markets were really falling hard, the bears, as you saw on my blog, went into an extreme level about 53% of their surveys. And you can see normally it’s around 30. Okay. So we’ve got all the indicators from both the AAII survey and of course, good old CNNs indicator suggesting that things are becoming a little bit too pessimistic by the so-called dumb money. Now, before you get upset about me saying the term dumb money, I want you to read that blog I just wrote because I explain the definition of dumb money. It doesn’t mean that retail investors, meaning the surveyed people AAII or even the CNN group that surveys a whole bunch of different people, by the way, including mutual fund managers.
It doesn’t mean they’re dumb. It doesn’t mean they can’t tie their own shoes. What it means is that on the whole, they act as a group. And if you read my last blog, you will see that that group tends to just kind of go with the flow. And that’s great because most of the time markets go up. But the problem with just going with the flow and the problem with buy and hold, or just kind of following whatever the newspaper or your internet news source tells you about the markets is that you reach the same level of extreme optimism and extreme pessimism as everybody else. So it’s not that being a Joe Blow average investor and following the crowd most of the time is a bad thing. In fact, we want to be trend followers and follow the crowd, but we want to have an exit signal when the crowd gets too optimistic.
And we want to have an entry signal when that same crowd gets despondent and everything I’m looking at right now indicates that about a week ago, when the S&P fell to 4,300, which by the way, wasn’t far off of my target. When I told you on my blog at 4,800, that I felt the market would fall. I said it would fall probably somewhere near 4,400 or 4,350, well it fell a 4,300. It actually briefly went below that, but that’s kind of a rounding error because that was intraday, whatever the case when that happened when the market hit 4,300, all these indicators, as you just saw, that was just two of them were screaming that things were overdone. So despite the volatility that we are seeing as I record this video on Friday, what is it? Friday, the 4th of February, there’s been a couple of days of noise on the market.
The signals I got a week ago, including the ones I just showed. You still suggest that the atmosphere is ripe for the market holding that 4,300 support level that I have talked about in the past and proceeding to move up. It may not happen right away, but proceeding to move up between now and the spring. Now, if you follow my work, you’ve read any of my books. And particularly if you’ve taken my recently announced technical analysis course, I talk about having some escape rules. So your prognosis is your prognosis, you follow some rules as far as to make a decision. So my rule was, hey, if it doesn’t break support and it shows sentiment indicators telling me that there’s going to be a turnaround, which is what we got a week ago, then I want to be in the market. Now that’s a rule.
That’s a buy rule because we had sold at the beginning of January. I eat my own cooking. And when I told you you to sell at the beginning, January I was selling and then I bought last week. Now the rule though is that if it cracks that old support of around 4,300, the game changes, we have to get out so you can be wrong. But the fact that sentiment indicators and that balance of support are there give me the weight of evidence to suggest that even though it may be a rocky ride over the next few months, the near term outlook for me as a more quantitative investor is likely positive, but we have an exit door if support is correct. It’s a pretty straightforward way of looking at things. It’s an unemotional way of looking at things. And that is why smart money, dumb money works because if we separate ourselves from that emotional reaction of the average retail investor, and instead we start following signals like the two I just gave you.
And that support level balance that I talked about. If we follow these signals, we will on average outperform the crowd and we have safety nets put in such as our stop loss signals that I just mentioned, a break of support, that take care of us if the prognosis turns out to be incorrect. It’s all statistics. We have a way of increasing our odds for success, but there are no guarantees. So we have a trading with the odds way of doing things and we have a what if things go wrong, safety net put into place. I hope this all makes sense. If it doesn’t, I urge you to take my technical analysis course. So thank you very much for watching and as always, if you or anyone you know, needs portfolio management using the tools, by a manager, I should say that uses the tools like we at ValueTrend do, by all means, we are here to help. Thanks for watching.
