Smart Money Vs Dumb Money Sentiment Shows Strong Divergence Of Opinion
Richard Shaw | Jul 27, 2014 02:17AM ET
There is a lot of talk about correction or melt-up. Opinions are divided, and both can occur with either occurring first.
Corrections (10% declines) are inevitable within a Bull market, but when is not possible to predict. Oftentimes they are primed to happen due to valuation, or weakening operating performance, but triggered by an outside event of some sort. We have had some big geopolitical events recently that have not had much impact.
The most important event in some people’s minds is a change in Fed interest rate policy (do note that stocks have done well in rising rate environments up to about 5% to 6% Treasury 10-year yield). The initial surprise of a directional change in interest rates, however, could cause some immediate negative stock reaction depending on what is done, and how much is done with rates.
In an attempt to gauge sentiment, surveys are constantly conducted, but opinions are not as reliable as investors putting their money on the line.
One way to dissect sentiment is to separate the decisions of institutional investors (presumably smarter and/or more logic based decisions) versus retail investors (presumably not as smart and/or more emotional decisions). The best indicator of the view of those two groups is to see the ratio of Put buying (protective) to Call buying (gain seeking) of each.
Institutional investors dominate the options market for indexes (such as the S&P 100), while retail investors dominate the options market for individual stocks.
This chart shows the ratio of Puts to Calls (the “Put/Call Ratio”) for the S&P 100 index and for individual stocks as a whole.
No indicator is perfect, nor should any be taken as a sole indicator, but this particular sentiment indicators suggests that professional investors are more in the camp that says a correction is due, while retail investors (who have been piling in lately) are more in the melt-up came (or at least “I’ve got to catch up camp”)
The clear opposite direction of change in the two Put/Call ratios shows the divergence of views between professional and retail investors.
This does not mean Bear market, but simply that a correction is viewed as likely (if not needed to wash out weak hands) in the minds of institutional investors.
We believe the longer term factors for the stock market are still positive, if less extreme that when we came out of the depths of 2009.
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