A ‘Dumb-Money Confidence’ stock-market gauge is flashing a warning

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One popular timing measure of Wall Street optimism is flashing a warning sign, says SentimenTrader.

A gauge of the confidence of individual investors, colloquially referred to as “dumb money,” was breaching a level at 0.67 that SentimenTrader’s Jay Kaeppel deemed indicative of trouble for forward returns in the S&P 500 index SPX, +1.61%.

SentimenTrader

“For at the moment, one of our ‘bread-and-butter’ measures — Dumb Money Confidence — as I look at it, is flashing yellow,” the analysts wrote.

SentimenTrader says the measure of “dumb money confidence,” which attempts to show what good market timers are doing with their money versus “bad” market timers, has been flashing yellow since Jan. 7.

The analyst report also noted that such warnings tend to be followed by below-average returns in the subsequent three-month and six-month periods. Kaeppel said, however, that returns in the ensuing 12-month period tend to be positive.

“Do we get a slow, steady advance like in 2017, a lot of volatility and some significant selloffs as in 2004 and 2010? Or full-on Armageddon like 2007/2008 and 2019/2020?”

Without knowing how things might shape up, SentimenTrader sees reason to play it defensively in the near-term.

“The reality is that it is impossible to predict exactly. But based on the history we just reviewed; investors may be wise to consider whether ‘playing defense’ fits into their investment plans, “ Kaeppel wrote.

The researcher says investors could raise cash or use options to protect against individual stock or broad-market losses, but he cited a change in attitude as, perhaps, the best way to deal with the new regime that he sees on Wall Street.

“The stock market has been generating a lot of ‘easy money’ profits in the last 6-9 months. This can act like a drug. It makes investors feel good for a while and increases their desire for more,” the analyst wrote.

“But the stock market is never a one-way street for long.”

On Monday, the Dow Jones Industrial Average DJIA, +0.76%, the S&P 500 and the Nasdaq Composite COMP, +2.55% indexes were attempting to rebound from a tough start to 2021, with worries about bubble’s forming in stocks like GameStop Corp GME, -30.77%. and AMC Entertainment Holdings AMC, +0.30%, raising worries among investors about market sentiment and the fragility of the recent bullish uptrend.