Highly Irrational Investor Optimism  Means Stock Market is Getting Very Scary.  We use investor sentiment as contrarian indicators of where the market is headed because historically investors are wrong.  Recent market record highs have made investors so giddily optimistic they are ignoring underlying indicators of weakness, such as the lack of breadth propelling the market to record highs. (see Chart of the Week).  In fact, recent days when the S&P 500 set records, more stocks went down than went up. So beware! The more the market reaches higher and higher overvalued levels, the further it will eventually tumble once reality sets in.

The CNN Fear/Greed, a good short-term contrarian indicator of market direction shows increasingly high investor greed.  And as the chart below shows, high levels of greed are followed by market downturns.  Another indicator that the market is on thin ice is the Smart Money/Dumb Money Confidence spread which compares trading by so-called smart and dumb investors. As the chart below shows the smart/dumb money spread has widened to a dangerous recent spread of – 0.6. Look at what happens in this chart to the S&P 500 market when the smart/dumb spreads have reached this kind of negative level.

Additional Caution:

More caution comes from the Investor Intelligence survey of market newsletter writers. The bulls edged higher to 57.6% from 57.1% the previous week. Bullish sentiment above 55% calls for defensive action.  Be aware that there was a sharp market downturn last August after bullish sentiment in this survey peaked at 58% in July. Meanwhile bearish sentiment was at 17.9% compared with 18% the previous week, yet another contrarian warning. Moreover, for the fifth week the spread between bullish and bearish sentiment expanded , ending at +39.7% compared with +39.0% a week ago (see chart). The bull/bears spread was +40% in late July just before the August downturn.

Conclusion: When high investor optimism ignores underlying market weakness, we get very concerned. And so should you.

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Surging Bullish Sentiment Signaling Stock Market is in Dangerous Territory.  We use stock market sentiment as contrarian indicators of where the market is headed. So we’ve been watching with growing concern the steady climb of bullish sentiment during the last few weeks towards levels that historically occur before short-term and intermediate-term downturns. For instance, trading of calls has been outpacing puts at a rate that historically has signaled a short-term downturn (see chart below). The put/call ratio recently was 0.65.

Chart from: SentimenTrader.com

Investors Beware

Meanwhile, things are looking equally bleak for the intermediate term as evidenced by climbing bullish sentiment from the Investor Intelligence poll of stock market newsletter writers/editors. During the past week bullish sentiment advanced to 57.1% from 54.2% the previous week, compared to October when bullish sentiment had fallen to 47.6%. To put this in perspective, bullish sentiment above 50% calls for caution. Bullish sentiment above 55% means investors should start taking defensive measures, including implementing tight stops and some selling of shares with large gains. It is important to note that bullish sentiment peaked to 58% in July followed by the sharp August selloff. We should note even more dangerous are the rare times when bullish sentiment climbs above 60% bulls. That last time that occurred was in Jan 2018, just before a major selloff.

Meanwhile, bearish sentiment was at 18.1, only slightly up from the previous two weeks. Bearishness below 20% is not generally attractive for broad buying. Meanwhile, for the fourth week the bull-bear spread expanded (see chart), ending at +39.0%, from +36.4% a week ago, compared with +30.4% at the start of October. Spreads moving above +30% call for increasing caution. Bull-bear spreads above+40%, such as occurred late in Late July before the August downturn, again call for defensive measures.

Sentiment Chart

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Investor Sentiment Suggests Stock Market Nearing Danger Zone

We use investor sentiment as a contrarian indicator of the direction of the stock market. An increase in bullish sentiment during the past week suggests the stock market is entering a danger zone, at least for the short term.  The Investor Intelligence Bulls/Bears poll of market newsletter writers and editors shows bullish sentiment during this week increasing from 52.8% last week to 54.2%. Bullish sentiment over 50% indicates investors should be cautious. A 55% level and above means investors should start taking defensive action. Meanwhile, bearish sentiment in this poll was pretty much unchanged at 17.8%. Anything below 20% means investors should not be thinking about a significant buying program.

Another note of caution in the poll from a contrarian viewpoint is that is that the number of market newsletter “gurus” expecting a correction decreased to 28.0% from 29.3%. Moreover, the spread between bullish and bearish sentiment expanded for the third week, to +36.4% from 34.9% a week ago (see chart). Differences as they rise above 30% call for increasing caution. Spreads above 40%, which occurred in late July, call for defensive measures.

Another spread signaling increasing danger comes from SentimenTraders smart/money dumb money indicator which shows the spread widening between the actions of smart and dumb traders falling into the -.40% danger zone (see chart).

Our conclusion? Remain cautious.

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We use investor sentiment as a contrarian indicator of stock market direction. Growing bullish sentiment is a warning for stock market investors. Bullish investor sentiment increased during the past week. This is an indication investors should be more cautious. The Investors Intelligence poll of market newsletter writers showed bullish sentiment at 52.8% an increase from 49.1% the previous week. Sentiment above 50% calls for caution. Bullish sentiment above 55% means investors should take defensive measures.

Meanwhile, bearish sentiment was 17.9%, slightly higher than the 17.0% the previous week. Bearishness below 20% is another indication investors should be careful, and certainly not embark on major buying programs. The spread between bullish and bearish sentiment (see chart) expanded for the second week to +34.9 from 32.1% and 30.4% at the start of October. Bull-bear spreads above 40% call for defensive measures.

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We use investor sentiment as a contrarian indicator of where the stock market is headed because investors historically are wrong. Based on the latest sentiment indicators we continue to advise investors to remain cautious, particularly in these times of volatile, roller coaster markets in which new stock lows greatly outnumber new stock highs. We should also note that markets often turn weak in late October.

So where is investor sentiment now? The Investors Intelligence Bulls/Bears poll of more than 100 market newsletters shows bullish sentiment increased to 49.1% this week after falling to 47.6% last week. Bullish sentiment above 50% is worrisome in terms of market direction. Bullish sentiment above 55% is a signal investors should take defensive action. Meanwhile, bearish sentiment remained very low at 17%, compared with the prior 17.2%. Bearish sentiment below 20% historically means the market has not yet reached a bottom and is not safe for broad buying programs.

Meanwhile, the spread between bullish and bearish sentiment in this poll (see chart) expanded slightly to +32.1% from 30.4% the prior week. Spreads above 30% are warning signs. Spreads above 40% mean investors should start taking defensive measures.

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