Bullishness at Contrarian Extreme

As a long-time student of the markets, I've learned that traditional "fundamentals" don't always tell the full story. For me, at least, it's also important -- essential, actually -- to take technical, sentiment, and macro factors into account when trying to figure out which way prices are headed.

That doesn't mean I always get it right. In fact, I've had more than my fair share of bad calls, especially when it comes to the shorter-term outlook. Regardless, I've found that my odds tend to improve when the aforementioned elements are all pointing in the same direction.

With that in mind, the following chart (courtesy of Elliott Wave International) and remarks by Tim Knight, from a post at his Slope of Hope blog (another long-time favorite of mine), entitled "Some Insights from EW," suggest that bullishness has reached a contrarian extreme:

The [following] chart shows the perverse relationship sentiment has with stocks. In early March, when stocks were a ridiculous bargain and multi-thousand percentage gains were just waiting to be plucked, the sentiment reading was an unheard-of 2% bulls.

Now, however, with stocks at (in my opinion) insanely-overpriced levels, and with all those multi-thousand percent gains already part of financial history, people are ga-ga about stocks.

Comments

[Michael Clark:]

Sudden events can change everything. But my charts currently do not show any indication of a change in trend. I know this is a fake 'Viagra Rally'. But as long as Ben is supplying the Viagra, the markets all go up. It is interesting that Alan Greenspan seems to be distancing himself a bit from his disciple, Uncle Ben. I wonder when doubt will begin to creep into to Uncle Ben's psyche? Or, to put it another way, I wonder when the civil war among the Fed governors will erupt, showing the 'inflate forever' ideology of the Ayn Rand followers begins losing its grip.

More disagreement among Fed governors is a good thing. Perhaps sanity will come out of this disagreement.

Oct 18 07:41 AM

[Michael Davey:]

Michael,

Can you elaborate on the makeup of EWI's sentiment index? There are no such extreme sentiment readings that I know of. Investor's Intelligence, for example is currently at 47.2% bulls.

I posed this question to Tim Knight yesterday and his answer was "it is right there on the chart," but I'm not sure he understood the question because nothing on EWI's chart explains what how these readings are comprised.

Tim Knight and now you are suggesting there were 2% bulls in March and subsequently inferring there are 92% bulls now (all according to EWI's sentiment index). There are no sentiment readings I know of at such extremes now and there were no sentiment readings from March which were as low as 2% bulls. I suspect the EWI index is extreme in and of itself (with no knowledge of how it is derived), but I challenge anyone to show us actual sentiment readings which show any such extremes.

Thanks.

Oct 18 10:54 AM

[enigmaman:]

Your remark " I know this is a fake 'Viagra Rally'" is a welcome one, it seems that many take issue with the thought that this rally will end one day, even if all the stars were lined up pricing for perfection it would eventually end, " Trees dont grow to the sky" This recent rally was for real that cannot be denied but to believe it will continue without the Gov intervention ( cash infusion) is quite naive, most of main street has not bought into this rally and have played it safe because unlike the generals sitting safe in their bunkers making calls we grunts see what is happing on the streets and it doesnt jive with what Wall Street, The Fed and the media want us to believe. It seems to me that anybody in this rally or not should be planning their moves for when something happens that will change the market for better of for worse because it will happen and when it does you should have your game plan ready for either scenario so you can react rationally rather then emotionally,


On Oct 18 07:41 AM Michael Clark wrote:

> Sudden events can change everything. But my charts currently do
> not show any indication of a change in trend. I know this is a fake
> 'Viagra Rally'. But as long as Ben is supplying the Viagra, the
> markets all go up. It is interesting that Alan Greenspan seems to
> be distancing himself a bit from his disciple, Uncle Ben. I wonder
> when doubt will begin to creep into to Uncle Ben's psyche? Or, to
> put it another way, I wonder when the civil war among the Fed governors
> will erupt, showing the 'inflate forever' ideology of the Ayn Rand
> followers begins losing its grip.
>
> More disagreement among Fed governors is a good thing. Perhaps sanity
> will come out of this disagreement.

Oct 18 11:18 AM

[enigmaman:]

To your remark "More disagreement among Fed governors is a good thing. Perhaps sanity will come out of this disagreement."

"Argument is a sieve for sifting truth" the current imbalance of power in DC is very dangerous, Rep have no voice at the table so we have to hope the Democrats will argue among themselves to get to the truth and do the right thing, the Fed governors as well, if not then what?


On Oct 18 07:41 AM Michael Clark wrote:

> Sudden events can change everything. But my charts currently do
> not show any indication of a change in trend. I know this is a fake
> 'Viagra Rally'. But as long as Ben is supplying the Viagra, the
> markets all go up. It is interesting that Alan Greenspan seems to
> be distancing himself a bit from his disciple, Uncle Ben. I wonder
> when doubt will begin to creep into to Uncle Ben's psyche? Or, to
> put it another way, I wonder when the civil war among the Fed governors
> will erupt, showing the 'inflate forever' ideology of the Ayn Rand
> followers begins losing its grip.
>
> More disagreement among Fed governors is a good thing. Perhaps sanity
> will come out of this disagreement.

Oct 18 11:24 AM

[Gavin G:]

Michael

Elliot Wave Intl take the Daily Sentiment Index from trade-futures.com
So you have to check on the same.This is a paid subscription mind you.


On Oct 18 10:54 AM Michael Davey wrote:

> Michael,
>
> Can you elaborate on the makeup of EWI's sentiment index? There are
> no such extreme sentiment readings that I know of. Investor's Intelligence,
> for example is currently at 47.2% bulls.
>
> I posed this question to Tim Knight yesterday and his answer was
> "it is right there on the chart," but I'm not sure he understood
> the question because nothing on EWI's chart explains what how these
> readings are comprised.
>
> Tim Knight and now you are suggesting there were 2% bulls in March
> and subsequently inferring there are 92% bulls now (all according
> to EWI's sentiment index). There are no sentiment readings I know
> of at such extremes now and there were no sentiment readings from
> March which were as low as 2% bulls. I suspect the EWI index is extreme
> in and of itself (with no knowledge of how it is derived), but I
> challenge anyone to show us actual sentiment readings which show
> any such extremes.
>
> Thanks.

Oct 18 12:18 PM

[InnocentsAb...:]

I am still of the opinion that trying to make sense of Federal policy as it has a impact on the markets and the economy is unlikely to produce a good prediction, unless you own the politicians in question (and even then, the law of unintended consequences holds).

Normal people (the non super rich) are best to recognize that there will be times when the unfortunate occurs (derivative meltdowns, monetary collapses, etc).

Given that, it is likely that all the best of times has been included in current equity prices -- leaving little room for bad news.

However, in the long run, the US will always be the best investment bet, for the simple reason that, crazy as we Americans are, we are more sane than everyone else.

Oct 18 01:31 PM

[Michael Davey:]

Thanks Gavin.

Curious how they get to 92%. I don't want to shout BS, but it sure smells like it. Sentiment is bullish just now perhaps, but nowhere near the extremes being suggested, I suspect.


On Oct 18 12:18 PM Gavin G wrote:

> Michael
>
> Elliot Wave Intl take the Daily Sentiment Index from trade-futures.com
>
> So you have to check on the same.This is a paid subscription mind
> you.

Oct 18 05:41 PM

[Steven Vincent:]

People are ga-ga about stocks? On what planet? There has never been a rally of this magnitude that has been greeted with such a degree of skepticism, worry and doubt. Every little reaction is proclaimed to be "The Top" and "The Collapse" has always just begun. Just another brick in the Wall of Worry, not a slip on the Slope of Hope!

Oct 18 10:17 PM

[SW Richmond:]

We've had a V-shaped recovery, all right. In stocks, and nothing else, and entirely on the back of bailouts, guarantees and backstops on the taxpayers' nickel to the tune of as much as $23 Trillion. Source: www.politico.com/news/...

None of the fundamental issues that caused the crash have yet been resolved. We don't know how many of the losses have been booked and how many remain hidden, in spite of the "new transparency". We don't know what marks are being taken for off balance-sheet (undoubtedly toxic) assets. We don't know how many houses remain to be foreclosed but for now are in a state of limbo. We don't know what happened to the 800,000+ jobs that disappeared into the BLS jobless adjustment somewhere. We don't know what will happen when CRE resets start in earnest.

Wall of worry? What worries me the most is that I'm not on Goldman's 'Friends and Family Plan'. Are there fortunes to be made here? Absolutely.

Oct 18 10:54 PM

[stockmarket...:]

I would also like to see the formula that made up this "sentiment index." If anyone can produce it I will tip my hat to you.

Oct 19 12:38 AM

[bbro:]

Does anybody realize we are just righting our valuations of the S&P 500 to NIPA Corporate profits????

Oct 19 02:42 AM

[twotraps:]

There is no real basis for this theory, but I don't think we should rule out some jarring, outisde event to cool off this rally. Since tech indicators are pointing up....pull-backs have been reasonable and orderly...earnigns seem to be fine and without sufficient rejection of any new high in the stock market, prices continue higher.

So, an outside event to somehow start an apparently innocent chain of events to cool it off and begin a more substantial correction than we've seen since March of this year. Some event to shed more light on the fact that the underlying economic situation remains very fragile. Not sure what this 'event' will look like, but won't it be funny to hear the tv business news change their tune to '.....we've told you all along that the fundamentals have been weak, and that stimulus is good but it also risks revealing whole charade of debt in this country.......'

Oct 19 09:50 AM

[stockferret:]

As with most of the previous commenters, I am very suspect of this bullish sentiment. In the numerous 'newsletters' in my inbox there is not even the slightest hint of bullishness. This website in particular seems incredibly bearish given what the market has done. Even CNBC.com has at least one headline a day on the impending market correction.

I don't buy into the fact that this market rally is the real deal but I haven't seen any bullishness that is out of the ordinary.

Oct 19 09:54 AM

[cyclingscholar:]

Watch what they DO....not what they say. If "Bullishness" is so rampant, why are puts so overvalued relative to calls on the SPY, DIA, and QQQQs? Because the same morons who missed last years CRASH have missed this years rally...and they want the train to back into the station...at your expense.

Oct 19 10:27 AM

[Mike Kane:]

this always occurs, its nothing more than riding the crowds, the type of momentum investing that so many employ...unfortunately this is going to kill long-term investors who use a "long only" investment model

Oct 19 01:13 PM

[Grueby:]

I do agree that on March 9th the maret was dramatically undervalued. Having said that, in spite of news such as Apple's reporting today I find that the market has simply gotten ahead of itself by at least 15 to 20%-maybe even as much as 25%. I don't see the broad fundamentals supporting these p/e ratios for year over year sales/earnings growth for 2010. Add that to the precarious dollar and the outlook is somewhat clouded. Bernanke spoke about a deficit reduction today. We need to strengthen the dollar. That is the real key.

Oct 19 06:19 PM