A valuable tool many professional traders track is the Investors Intelligence Advisory Sentiment. This survey tries to determine the mood of the market by polling over a hundred advisory newsletters and tallying how many “bulls” and “bears” there are at the moment.
It also takes into account the “chickens” which are the newsletters that expect a correction. When sentiment tilts too much to one side, usually the market is affected by an important correction or hits a major top or bottom.
When the market topped in late 2007, the bullish sentiment peaked with approximately 60 percent of the newsletters polled indicating they had a bullish forecast. On the other hand, as the market bottomed between late 2008 and March of this year, sentiment was tilted towards the bears which peaked at 55 percent.
As you can see, the Investors Intelligence Sentiment Index is a contrarian indicator. Too much optimism is bearish for the market and too much pessimism is bullish.
This Wednesday, Sept. 15, the market received the latest stats from the index. They showed 47.8 percent of the newsletters polled were bullish and 24.4 percent were bearish. Even though the market is making new highs, bullish sentiment actually dropped compared to last week’s reading.
While sentiment is clearly tilted to the optimism side, we are still away from the extreme bias of 60 percent bulls. This would indicate that, despite an almost 60 percent move from the bottom in the S&P 500, we haven’t yet reached a top.
There is an old adage on Wall Street that says: Bear markets slide in a slope of hope, while bull markets climb a wall of worry. Based on the Investors Intelligence sentiment stats, there are still a lot of bears worrying and disbelieving that this market can keep moving higher.
Once most bears lose their fear and turn to the bullish camp and euphoria dominates the market, then it’s time to fret, close long positions, and think about shorting.
I understand the bears’ concerns. In my columns, I have highlighted many of the economic problems the United States is facing and hasn’t fixed yet. Actually, these problems have been made worse by government intervention.
With money printing and stimulus packages, the government has effectively kicked the can for a while and orchestrated one of the greatest stock market rallies in history.
The day of reckoning will pass, but I don't know when it is going to happen. Politics are at work now, distorting the free market’s invisible hand.
Despite my bearish comments on the economy, I have always advocated following the trend, which is clearly bullish. Sometimes the technicals and fundamentals totally conflict, and it can be very hard to take a stance.
You can be a genius in economics and correctly forecast what should happen. Bottom line, though, the market can remain irrational much longer than you can stay solvent if you trade against the trend.
Stay with the trend and buy the dips. This is what has been working so far and should be repeated until proven wrong.
However, keep an eye on the Investors Intelligence Advisory Sentiment. Once we reach 60 percent bulls and you start hearing about a Goldilocks economy and economic nirvana, then it’s time to start worrying and cash out.
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