The Dumb Money Is Too Bearish

The reversal of the reversal yesterday provided a few more extremes among our indicators, pushing the percentage currently at a bullish (for the market) extreme to the highest level since November 2008.

And while it has taken a bit longer, that's started to become reflected in the Dumb Money Confidence, which has sunk from a whopping 75% on April 14th to under 30% as of yesterday.

There are a couple of caveats about the current extreme. First, the Smart Money Confidence is only at 50% - I would much prefer to see it above 60% or even 70% to help confirm that we're truly at a likely intermediate-term buying opportunity.

Second, the Dumb Money has dropped quite a bit more at some of the near-panic lows during 2008, declining to between 10%-20%, so there's a chance it could become even more stretched than it is currently.

But it's relatively rare to see such pessimism, then as large a gap down as we're indicated to endure this morning (more than -2%). The table below shows each instance, along with the S&P 500 futures performance going forward (assuming one buys the market at the open of the gap down).

Date	That Day	1 Day Later	3 Days Later	1 Week Later	2 Weeks Later	1 Month Later	3 Months Later
10/26/87	-3.4%	0.3%	7.8%	13.1%	7.7%	8.0%	9.8%
10/28/87	5.1%	11.7%	17.2%	13.7%	10.1%	7.7%	15.6%
09/10/98	-1.3%	3.2%	5.5%	5.0%	7.0%	2.4%	18.8%
09/21/98	2.6%	3.5%	5.0%	5.9%	-1.0%	7.0%	21.0%
10/08/98	1.6%	3.9%	5.1%	11.5%	13.9%	20.3%	33.5%
09/21/01	3.5%	7.2%	7.9%	11.0%	14.0%	16.3%	21.4%
06/26/02	2.4%	4.2%	1.9%	0.1%	-2.6%	-10.3%	-11.6%
07/24/02	8.5%	7.6%	14.9%	17.2%	12.6%	23.5%	14.6%
01/22/08	3.3%	5.8%	5.3%	7.5%	6.0%	6.3%	8.9%
01/23/08	5.4%	6.2%	6.4%	6.1%	4.5%	6.5%	8.3%
03/17/08	1.5%	5.8%	5.1%	7.3%	8.8%	8.8%	7.8%
10/06/08	-2.2%	-6.6%	-15.2%	-5.6%	-8.0%	-6.8%	-13.6%
10/08/08	0.3%	-6.7%	4.0%	-7.6%	-7.7%	-7.5%	-7.3%
10/10/08	2.3%	16.7%	3.7%	7.2%	-0.6%	5.8%	-0.3%
10/15/08	-7.7%	-3.8%	1.2%	-7.7%	-5.3%	-7.2%	-14.2%
10/17/08	1.3%	7.5%	-2.0%	-6.0%	5.0%	-7.7%	-12.5%
10/21/08	-1.1%	-6.9%	-10.7%	-3.2%	3.5%	-16.2%	-14.9%
10/22/08	-2.9%	-1.6%	-10.3%	-0.3%	3.0%	-19.5%	-11.5%
10/24/08	3.1%	-0.6%	10.4%	15.2%	11.5%	1.0%	-0.1%
02/27/09	-0.1%	-4.0%	-3.7%	-6.5%	3.1%	6.7%	24.9%
03/02/09	-1.9%	-4.1%	-4.6%	-6.0%	5.3%	10.5%	30.6%
Average	1.0%	2.3%	2.6%	3.7%	4.3%	2.6%	6.2%
% Positive	62%	62%	71%	62%	71%	67%	57%

The returns aren't eye-poppingly bullish...but that's mainly due to October 2008. If we suspend reality for just a moment and ignore that exceptionally volatile period, here's what the Average and % Positive rows would look like:

Date

That

Day

1 Day

Later

3 Days

Later

1 Week

Later

2 Weeks

Later

1 Month

Later

3 Months

Later

Average

2.1%

3.9%

5.7%

6.6%

6.9%

8.7%

15.7%

% Positive

69%

85%

92%

Much better. But again, that's not reality. We did experience October 2008, and there's a possibility we're in the midst of something similar now - it's doubtful, but possible. More likely would be a period like January 2008 when the markets were just coming off their highs, got oversold, then dove lower for a few days before recovering.

We have a large number of extremes currently, which is a consistent buy signal during a bull market (objectively defined as a rising 200-day moving average on the S&P 500). The only real exceptions are during periods of major trend change, and it's one reason why I felt we were heading into a bear market in January 2008 - the market just did not respond properly to bullish setups.

If we see the same kind of failure here, which should be clearly evident over the next couple of days, then we'll have a pretty good indication that the bull market has ended and we'll be seeing that 200-day average start to slope downward again. Then it will be a time to look for rallies to sell instead of dips to buy.