If you’ve followed my work for any amount of time, you know the buying and investing activities of small investors are the best contrarian indicators in the market.
As I’ve said hundreds of times, the small investor, Joe Mainstreet, is 180 degrees out of sync with the market. So if Joe is buying, you’d better have your sell stops in place.
The shock of the 20% drop in the market in the last quarter of 2018 appears to have faded from view. (That didn’t take long… it never does.) And the big move up in the market since January 1 has put the icing on the “buy at the top” cake.
The latest numbers from E-Trade’s StreetWise survey indicate that self-directed investors, the little guys, now consider themselves bullish. At the start of this year, 54% considered themselves bears; but in just three months, 58% considered themselves bulls.
What’s changed?
We’re approaching a new high – the worst time to be a new buyer. But historically speaking, it’s when the little guy starts his buying, and it’s the first indicator of a top.
If you require a more technical explanation of how bad the small investor’s seat-of-the-pants instincts are, the S&P 500 Index has historically realized lower-than-average and lower-than-median six-month returns following low, bearish sentiment readings.
In the week ending on April 10, 5.3% more people described themselves as bullish. During the same week, the reported “bearish indicator” dropped by 7.9%. Those are huge shifts for one week.
The other, almost infallible indicator of what the little guy is doing is the measure of inflows to equity funds. In the same week in April, there was an inflow of $4.3 billion into stock funds versus a $19.7 billion outflow from those funds since the first of the year.
We also saw $8.4 billion in outflows from cash sources, such as money market funds, in the same period. The little guy is moving into stocks in a big way and, as always, for all the wrong reasons and at the wrong time.
But buying at the top is only one leg of the three-legged stool. At least two more pieces have to fall into place before we can see smoke…
When I was calling the top last September, we had an indicator from Fidelity that first-time investors were buying the most aggressive investments on the market.
That’s the second leg – but I don’t see any indication of that repeating yet.
The third is irrational exuberance. That’s when everyone you talk to is asking for stock tips. That’s just starting, and it will get worse. It always does, especially near a new high.
I’ve never seen any documentation of this, but if there is a fourth leg, it’s made up of the psychological barriers in the market.
I’ve lived through the Dow at 5,000, 10,000 and 20,000 – and now it’s near 30,000.
Getting through each of these mental walls has been a circus to watch. The media can’t stop screaming about the activity from the Dow, S&P and Nasdaq, and the little guy bites on that emotional hook every time.
So does this mean we go to cash, sit back and do nothing? No – that’s throwing gas on the fire (and a talk for another time).
But if the markets of 2008 and 2009 taught us anything, it is that sell stops will save you from market insanity.
Oxford Club Chief Investment Strategist Alexander Green and his team turned a profit with his sell stop system when the whole world was going down the toilet back then. And that’s all the proof I need about the viability of sell stops.
Trying to time the top or the bottom of the market is a fool’s game – I know that. But ignoring the small-investor indicators that have preceded all sell-offs is not smart.
It’s getting hot out there. Keep your eyes on the horizon, your ear to the ground and your stops in place.
Good investing,
Steve
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Source: Wealthy Retirement