The Mindset and Impact of Retail Investors - TheStreet

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.


) -- The recent rally has been breathtaking, however the majority of investors have missed out on a large portion of these gains as significant levels of cash have been either moved to bond funds or taken out of equity markets consistently during this rally. Let's face it, financial markets around the world are not what they once were.

U.S. equity markets in particular are manipulated by high-frequency trading which is wreaking havoc in the marketplace in terms of potential short-term volatility expansions and "flash crashes" that can be isolated to one underlying stock.





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In addition to the high-frequency-trading robots, the

Federal Reserve

is equally involved in the direct manipulation of financial markets through record easing adjustments. The Federal Reserve has unleashed massive amounts of liquidity while keeping interest rates incredibly low which has produced an environment where the risk-on attitude permeates the landscape.

As a basic example of the failure of recent Federal Reserve policies and their impact generally on the valuation of various underlying assets, I submit for consideration to readers a 20-year price chart of the U.S. Dollar Index.

20 Year U.S. Dollar Index Chart

It boggles the mind to consider that Chairman Benjamin Bernanke routinely denies that the Federal Reserve has failed to maintain what he calls "price stability." When looking at the chart of the valuation of the U.S. dollar against a basket of foreign currencies, most fifth graders would proclaim the Federal Reserve has failed in their objective to maintain price stability.

As time passes and the financial crisis moves further into the rear-view mirror, average Americans have varied views about the economy, the stock market, and trust in their government.

Now more than ever, regular people are not only distrustful of domestic financial markets, they do not trust Wall Street -- and for good reason. In light of this, data compiled during the recent uptrend suggests that retail investors have been pulling money out of equities for weeks even though prices continue to move higher. The chart shown below, courtesy of

, illustrates the recent trend.

U.S. Domestic Mutual Fund Flows

The chart above shows the price of SPY represented as the black line and equity fund inflows/outflows as the red area. As can be seen, retail investors have been pulling massive amounts of capital out of equity-based mutual funds over the past few months as equity prices have rallied. The retail crowd, commonly referred to as sheep -- or, courtesy of Goldman Sachs, "muppets" -- are selling into the rally.

So why is the retail crowd selling? They do not believe that this rally will last because the real world around them is arguing in the face of everything that this rally stands for. Gasoline prices are crippling the lower and middle classes, further reducing their disposable income. Higher food and energy prices paired with job scarcity and serious concerns have begun to mount.

The average retail investor believes the game is rigged at this point and the everyday investor is only helping Wall Street bankers fund their lavish lifestyles. Ultimately, the retail crowd likely believes that the only way to win the game is to simply not play.

Will time prove the supposed sheep wrong? Statistically one would think so, but in this case the retail folks may just be right. Headwinds surround the global macroeconomic landscape. Europe is moving into a recession exacerbated by austerity measures. Data came out Thursday that the purchasing managers' index in several European countries and China contracted. Ireland missed growth targets and central banks around the world continue to print unprecedented levels of fiat currency as if printing money and creating more debt will solve a debt problem.

All of these issues are concerns, but ultimately price is the final arbiter in the world of flickering ticks. There are two possible outcomes for the price action in the

S&P 500

. The first and likelier outcome is a test of the 2011 highs that results in a snap-back rally, taking us deeper into the 1,420-to-1,440 resistance zone. The chart below demonstrates the bullish potential outcome.

SPX Bullish Outcome

Price action at some point will backtest the 2011 highs and the reaction at that point will be critical. Generally speaking price action does not break a key support or resistance level on the first attempt. Usually the second or third attempt will result in a break.

In this case, a test in coming days would likely result in a bounce and reversion to the previous trend. A possible, albeit unlikely outcome would be a break below the 2011 support zone which would then come close to triggering a trend change. The daily chart below demonstrates the bearish potential outcome.

SPX Bearish Outcome

I do firmly believe that the U.S. Dollar Index will hold clues about the future for the price action of equities. According to cycle analysis, the dollar should come into is daily cycle low sometime in the next few weeks, if not sooner.

From that low, we should see another move higher for the Dollar Index which I anticipate will test the recent highs near 81. The daily chart of the U.S. Dollar Index futures is shown below.

U.S. Dollar Index Futures Daily Chart

If my expectations are somewhat accurate, the short-term weakness in the dollar will assist stocks and risk assets in a move above recent highs. In the case of the S&P 500, a move to key resistance at 1,420 to 1,450 could occur.

Readers should keep in mind that weakness could be disguised as a consolidation near the 20-period moving average, which has occurred in the past when analyzing the Dollar Index. However, I would not rule out one more leg lower before the dollar finds a bottom.

Gold, silver and the miners have been under selling pressure for some time and are likely due for a bounce to the upside. The weakness in the dollar discussed above would allow precious metals and miners to work off some of the short-term oversold conditions that we are seeing presently. The daily chart of gold futures is shown below.

Gold Futures Daily Chart

After a move higher into or around the $1,700/ounce price level for gold, I believe that another leg lower will be quite likely.


Readers should be mindful that the first quarter will end on March 30 for financial markets. Window dressing and portfolio painting are likely to occur next week. I would not be at all surprised to see the tape painted to the upside during the final week of March after this brief pullback that we witnessed on Thursday and Friday morning.

Money managers want to show off their returns while demonstrating ownership of key names that drove performance during the quarter, such as


(AAPL) - Get Report

. I expect the price action on Friday and the rest of next week to have relatively light volume and a bias to the upside.

Barring any major financial news or geopolitical event, I do not expect to see price action work below the 2011 highs in the near term. The possibility cannot be totally ruled out, but it would seemingly be a rare occurrence to see a major support level break down on the first back-test attempt. We may see lower prices early next week, but if the 2011 highs hold, the bulls remain in control in the short term.

The real question readers should ask themselves is if prices do extend higher and we reach my target resistance zone for the S&P 500, will the retail crowd jump in and push prices higher, or will the banks be trading with each other as a major top forms? In coming days and weeks we should find out once and for all just who the real muppets truly are.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

Chris Vermeulen is founder of the popular trading sites and There he shares his highly successful, low-risk trading method. Since 2001, Chris has been a leader in teaching others to skillfully trade in gold, silver, oil and stocks in both bull and bear markets.