Dumb Money Chart
Research for Online Investors

by John Dalt

1/19/11

What is your plan?  A friend’s mother has Alzheimer’s disease, a very sad situation.  He is resigned to watching his mother grow more distant.  She was a successful professional, and now is not able to take care of herself.  Many may not know it, but some patients lose the ability to speak, and just gaze into space with a blank stare.

I am sorry to bring up such a depressing subject.  But I have a point to make here.  How are you handling your investments and trades right now?  Do you wake up every morning, amazed that the sun came up and confident everything will be just fine?  Do you have an expectation the market will climb higher and all will be ok?  Are you overly bullish? Or, are you betting everything against the market moving higher?  We don’t want to encourage either ‘plan.’

More than likely, if you are like many retail investors, you are in the optimistic camp.  You may not be all in, but you are probably close.  Don’t get me wrong, the market has been on a heck of a run.  For the last seven weeks we have moved higher.  But deep inside, don’t you know it has to end sometime?

Below is a great chart I refer to when I need detachment from the current market and want to understand market sentiment and its relation to stock prices.

This chart is the S&P 500 stock index divided by the VIX index. We are looking at the value of the S&P and dividing it by the index that measures investor sentiment (the fear gauge). It should not surprise you that investor’s feel warm and fuzzy right now. Everyone is sitting on gains and is relatively happy with how they have done.

I call this the Dumb Money chart.  I pay attention when this chart hits extremes.  The market has climbed long enough for everyone to jump on board.  Many are sitting on gains, but this hot money will jump at the first sign of trouble.  Some market participants fancy themselves as traders.  They are the last in and  the first out at the high extreme, and late to sell and slow to come back on the low extreme.  They don't recognize the market is inticing them to lay down their money, only to watch it be snatched away!

You can see what happened in September 2008 when the chart was at a high ratio, then March 2009 as it bottomed at the opposite extreme.  We can trace the climb back to April 2010, then the bottoming in June and July.  Please notice we have climbed back and are higher than last April or for that manner September of 2008.

This is complacency writ large, but for me it causes fear.  Make sure you are monitoring your stops.  Consider selling at least part of your largest positions.  If you have some big gains, chances are those stocks make up too large a percentage of your holdings. Now would be a good time to take some winnings off the table, and put your portfolio back in balance.

This chart wants to come back in balance.  We have used a 900-day moving average for the red line to illustrate a good point of reference.  Balance can be restored by the S&P moving lower or the VIX index climbing higher.  Which will it be?  These two indexes do not necessarily move independently.  A falling S&P creates investor fear which raises the VIX index.  But, we could go through some consolidation days that are not that destructive of the market.  This would raise the VIX and help bring us back in line.

We will watch our Dumb Money chart for our next buying opportunity.  Selling into the present market looks like a better long term strategy.  We sold one of our stocks last week in the Long-Term Portfolio.  We have a tight $trailing stop on another right now, and we are ready to issue another tonight.  Wouldn’t it be nice to have someone watching your back?  You can subscribe to our Long-Term Portfolio and enjoy great returns without the worry.  You will get in on our sell strategy, then be ready to buy our next recommendation.

To the mailbag:
Obama may be a marvel, but he is ours and he will even win over the Chinese---paid up subscriber G.O.

John’s reply:  He won't win them over.  They recognize him as weak.  Why else would their military test their stealth plane that was stolen and copied from the U.S. while Sec. Gates was in China?  Please don't think that they didn't know what their military was doing.  Did you hear today that GE is going to show the Chinese how to build their latest generation jet engines?  He admires their socialist government.

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