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The latest sentiment reading by Investors Intelligence shows a disturbing trend. Only 15.6% of financial newsletters are currently bearish on equities.

Last time the bearish indicator was this low was April 1987. A few months later (Black Monday) the DJIA dropped 21% in a single day:

In other words – when everything seems peachy — watch out. Turns out that peaks and troughs in investor sentiment are pretty good contra-indicators. Bullish sentiment tends to peak as bubbles are near their top, and vice versa.

From the revamped and newly Bloombergesque Business Week:

Pessimism about U.S. stocks among newsletter writers fell to the lowest level since April 1987, six months before the equity market crash known as Black Monday, following the biggest rally in the Standard & Poor’s 500 Index in seven decades.

The proportion of bearish publications among about 140 tracked by Investors Intelligence fell to 15.6 percent yesterday from 16.7 percent a week earlier. Sentiment has improved since October 2008, when the financial crisis drove the figure to a 14-year high of 54.4 percent. After plunging 38 percent in 2008, the S&P 500 has risen 25 percent this year.

This is not to say markets won't run again in 2010. Irrational bull markets can last much longer than you’d think. The momentum they build up is impossible to fight. Gotta wait for that to break before getting seriously short. Example: after the bearish-sentiment index bottomed in 1987, the market rallied another 14% before crashing.

Smart investors like Bill Fleckenstein have been highlighting the credit bubble since the mid-1990’s. And today, markets are more irrational than ever. Government intervention is preventing market cycles from proceeding like never before.

Industries like housing, banking, and commercial real estate have become completely dependent on government support. Their future (and that of our currency) depend on whether our leaders will extend or end this support. It’s a ludicrous, manipulated market.

So far America’s leaders have repeatedly demonstrated that they have zero tolerance for economic pain. Their support for the financial markets seems unlimited, no matter the long-term cost. I don’t see that changing without something drastic happening – another huge round of bailouts, a shift in the political landscape, or something else.

Earnings Distorted, Bloated

Earnings, as officially reported, are less and less reflective of a company’s real income.. Today’s earnings are nothing less than a rosy version of what they “should of been, had not X happened.” X represents the bad stuff that constantly happens to businesses, but currently they are treated as one-time events, no matter how many quarters-in-a-row they occur. One-time transactions that are profitable, however, are included in “headline” earning numbers, of course.

This is a different breed of bubble. On top of creative income interpretation, asset losses are being swept under the rug with an impressive array of accounting gimmicks. Changes to rules that govern loan valuation, and the continued allowance of off-balance-sheet vehicles are examples.

Source: Disturbing Trends: Bearish Sentiment at a 22-Year Low