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Stock Market Investor Sentiment, Is it Providing a Warning?

Stock-Markets / Stock Market Sentiment Apr 17, 2010 - 05:38 AM GMT

By: Sy_Harding

Stock-Markets

Best Financial Markets Analysis ArticleInvestor sentiment is known as a contrary indicator. Here’s how that works.

When a market correction is underway investors naturally become increasingly fearful and bearish as prices continue to fall. By the time the correction ends, investor sentiment has reached a high level of fear and bearishness.


In the other direction, as a rally proceeds, investors become increasingly optimistic and bullish. So by the time the rally has lasted for some time and the market has become overbought and due for a correction, sentiment has reached a high level of bullishness and confidence.

Thus is investor sentiment a ‘contrary’ indicator, since it is extremely optimistic at market tops, and extremely pessimistic and bearish at market lows.

I bring that up because at the present time there are a number of sentiment measurements that may be flashing warning signs.

The VIX Index, also known as the Fear Index, has been attracting attention for more than a month. After spiking up to a record high level of fear as the bear market approached its low last March, the VIX has been plunging as the rally off that March low has continued non-stop. It is now at a low level of fear (high level of optimism) that has been seen only four times since 2007: On October 9, 2007, at the top of the 2003-2007 bull market; in December, 2007, the top of a mini bear market rally; on May 19, 2008, which was the market’s exact high for 2008; and on January 19 of this year, when the January-February correction began.

In another method of measuring investor sentiment, this week’s poll of its members by the American Association of Individual Investors, showed bullishness has jumped to 48.5%. The AAII poll is usually considered to be giving a warning when it reaches 50% to 55% bullish. It reached 54.6% bullish in October, 2007, at the exact top of the 2003-2007 bull market. And it reached 52.8% bullish on May 8, 2008, which was one week before the market began its serious 2008 bear market plunge.

However, it only reached 47.5% bullish on June 4, 2009, and a correction began a week later. And it only reached 47.4% bullish on January 14 of this year, and the January-February correction began a week later. So at its reading this week of 48.5% it is again in warning territory.

Then we have investor sentiment as measured by Consensus Inc. It measures the sentiment of brokerage firm analysts and independent advisors. Its sentiment reading is now 75% bullish. The last time it reached that level was in October, 2007, near the top of the 2003-2007 bull market. It reached a high of 64% bullish in January of this year, just prior to the January/February correction.

Meanwhile, it’s interesting that while the sentiment of options players, brokerage firm advisors, public investors, newsletter writers, etc., the groups that are considered to be ‘contrary indicators’, have reached these high levels of bullishness, corporate insiders have been selling into the strength. Trim Tabs Inc. reports that insider activity in March was decidedly on the sell side, with insider selling amounting to $6.9 billion, while purchases amounted to only $0.83 billion.

The market cannot be timed by investor sentiment alone.

However, just as the major market indexes were oversold beneath their 20-week moving averages at the market low last March, they are now overbought above those moving averages.

A potentially overbought market, and unusually high bullish investor sentiment, just as the market approaches the time when traders will be thinking of the Sell in May and Go Away maxim, is probably not a comfortable situation for bullish investors.

However, it usually takes a catalyst to reverse market direction even when the conditions are in place for a potential reversal.

Could Friday’s surprising news that the Securities & Exchange Commission has filed civil fraud charges against Goldman Sachs possibly be that catalyst?

Goldman was the golden bank during the financial collapse in 2008, favored by the Treasury Department and SEC. The SEC alleges that Goldman sold investors $1 billion worth of mortgage-backed securities in 2007 that it issued at the request of a large hedge fund client, Paulson & Co., which wanted the securities to sell short on expectations that they would plunge in value. If true it could have implications for financial firms that are not as highly respected as Goldman Sachs.

One positive result is that Wall Street firms will have a harder time now in lobbying to have proposed regulatory reforms watered down.

Sy Harding is president of Asset Management Research Corp, publishers of the financial website www.StreetSmartReport.com, and the free daily market blog, www.SyHardingblog.com.

© 2010 Copyright Sy Harding- All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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