One of the things I always find fascinating about the markets is the degree to which they move based not on fundamentals, but rather on sentiment. Perhaps we could call it psychology or even supply and demand. Anyway, I have learned there are some absolute non-negotiable truths to this sentiment stuff.
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You have probably heard that it is best to buy when everyone is selling and sell when everyone is buying. At extremes, such is currently the case with the SP-500, that actually makes sense. At the extreme where bullish sentiment is sky high, you finally run out of buyers to push price any higher. The preponderance of market participants with long positions run out of money to take additional long positions and they also have a vested interest in selling to turn their 'paper profits' into something they can reap as the reward - cash. And conversely, at the extreme where bearish sentiment is black and ugly, you finally run out of sellers who will continue to propel downward valuation, everyone has cash, no one holds stock, and so you have the perfect fuel for a powerful rally.
Here is a chart of the current Investor's Intelligence sentiment reading for the stock market. The link to this data at Schaeffer's Research is here.
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What we find is that the current reading of bulls is nearly 57%. There is no other way to characterize that reading other than to call it 'sky high'. In fact, the reading that preceded the mini-crash of this past May was slightly lower!
This is a daily chart of the SP-500 I made using the software freely available at FreeStockCharts. What I have done is put the weekly sentiment data of the Bullish % on the chart going back 9 or so months to last April.
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The True Strength Index (TSI) indicator is now showing a negative divergence with the continued rise in stock price. That's never a good sign. What's more, another week or two of simply sideways price movement will cause the indicator to continue falling right through the trend line drawn in blue and thus create a SELL signal.
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It may be a good idea to take some profits now, before the stampede to get out the door.
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Click on the charts to ENLARGE
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Good warning about the market valuation. I've sold off most of my positions over the past few days and am mostly just doing day-trading now. Like you, I've had a sense that a significant market correction is incoming through the beginning of the new year, so I've been very skittish about making any new long-term trades.
ReplyDeleteThere is one important distinction to make about the current market sentiment versus the prices in May, though. Current sentiment about the recovery of the American economy is based on real numbers now, which wasn't necessarily the case in May -- when recovery was more speculative.
To me, the biggest concern is the federal deficit. The tax breaks announced recently might be devastating to the dollar over at least the next year or two. This can have wide-ranging ramifications. Long-term outlook on commodities is for growth in precious metals value as the dollar (world reserve currency) quickly becomes devalued by debt and excess printing of paper money.