Like price and valuation, sentiment vacillates from one extreme to another. This year we've experienced positive sentiment and now are in a period of negative sentiment, which seems to be growing.
Meanwhile, the PowerShares QQQ Trust, Series 1 (QQQ) sits 9% below its high, and the SPDR S&P 500 (SPY) is 6.5% below its highs. The sell off seems well contained within the main US indexes, however, a different story emerges when looking at European indexes, Asian indexes, and commodities. The risk off trade is also at highs with the iPath S&P 500 VIX Short Term Futures TM ETN (VXX), iShares Barclays 20+ Yr Treas.Bond (ETF), and the US dollar (UUP) at YTD highs.
Given these developments in the last month, I wanted to examine some sentiment indicators to see where we stand. Like any tool, sentiment is not the be all and end all, however, it can help manage risk. Sentiment can help prevent one from entering a crowded trade late and from entering a trade too early, compromising one's ability to take action at more attractive prices.
This measure is computed by Market Harmonics, based on fund flows.
The put/call ratio is signaling bearish sentiment as well and has hit levels that correspond to turning points.
The VIX has also climbed with the markets falling, reflecting greater fear. The orderliness of the sell off is reflected in the VIX's gradual ascent.
This measure is also reflecting the market's internal weakness and has fallen to levels that correspond to previous buying opportunities. However, it seems more prudent to wait for a higher low.
Sentiment indicators are as useful as contrarian indicators. Once everyone is on the same side of the trade, nasty reversals tend to occur. However, the trend must be respected and many losses are taken by fighting the trend.
My takeaway is that sentiment has reached bearish levels where reversals tend to happen, however, it is not at extremes. I would advise caution as there is a great deal of headline risk. In contrast, bull markets shrug off bad headlines as they climb the wall of worry.
I remain comfortable with my prognosis of a range bound market, the odds don't favor those panicking or shorting amidst elevated levels of fear. I continue to focus on 1340 in the S&P 500 as a key level that would open up opportunities on a visit to the upper part of the range.