Market sentiment is still too frothy.

Not much has changed in the last week.

The spread between the bulls and bears has come in a bit. It’s gone from 43 to 32. This is normal as a small correction has started to make some folks nervous. 

However, this is likely just a start to the cycle of fear. We are nowhere near the levels of pessimism needed to mark a meaningful low.

Market sentiment is still too frothy

As our last two Chart’s of the Week discussed, market valuations and price action suggest there’s a lot of risk in the markets right now. 

Can the market rally from here?

Of course. However, when you add sentiment that is too bullish into the mix with the other issues we have recently highlighted, any gains from here will likely be wiped out. 

There’s almost surely going to be a more favorable spot to buy stocks from here.

The Active Alts SentimenTrader Long / Short strategy uses numerous indicators, including sentiment, to identify market extremes and adjust exposure accordingly for superior risk-adjusted returns. To learn more, visit activealts.com 

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Market Sentiment  is No Where Close to a Buy Signal.  The bulls dropped to 54.8%, from 59.0% last issue. Late Aug saw 61.5% bulls, their highest reading since Sep-2018 at 61.8%. (Mid Jan-20 saw them up to 59.4%.) Our rules says above 55% bulls needs defensive measures – tight stops at the minimum and possibly some selling among shares with big gains. Bulls 60% and above signal increased danger the higher they get, and the need to prepare for a market decline. Sentiment top signals can take months before markets decline. The final Aug bull count was up substantially from just 30.1%, shown near the 23-Mar market lows. That was the fewest since Dec-2018 ended with a similar 29.9% count. Bulls near 30% say cash is high after a market tumble for a lower risk buying chance. The signals for market bottoms occur much more quickly than indications for market tops.

The bears increased to 18.3%, from 16.2% a week ago. That equaled their 2½ year low shown twice in Aug. The new bears moved from the correction outlook, raising more cash and now projecting a resumption of the Mar selloff. Very low bearish readings do not suggest strong rally potential. Lots of bears do! Now we await a further buildup in their reading to signal a bottom. That occurred as stocks tumbled to late Mar lows, with the bears jumping to 41.7%. They also outnumbered the bulls for three straight weeks to signal a buying chance. That situation has been rare since the 2008-9 financial crisis. Similar elevated bearish levels were also shown Dec-18 and Feb-16, when other market selloffs ended. Bears below 20% are not favorable for longs, while high readings, especially when they exceed the bulls, are indicative of market bottoms.

The bull-bear difference narrowed to +36.5%, from +42.8% last issue. That ends five straight +40.0 spreads, which signaled elevated risk and a potential decline. Aug ended with the widest spread since Jan-2018 when it exceeded 50%! In contrast, the Mar-20 lows had a -11.6% negative difference. Then the bears outnumbered the bulls for three weeks. That has been rare since 2009. Negative spreads point to lowered risk for longs the larger they get! Other similar buying chances were -4.7% in Dec-18, -14.5% in Feb-16 and -25.0% in late Oct-08. In contrast, that Jan-20 peak spread was followed by a mid-Feb-20 reading at +35.8%, as indexes hit repeated highs to start this year. Above +30% counts show more risk the higher they get, with defensive measures appropriate above 40%. Prior to +41.5% in Jan this year we saw a +43.2% spread late Sep-18, just before the S&P 500 corrected 19.7% to its Christmas Eve low that year.

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Despite Stock Market Downturn Investors Continue To Live in Fantasy World of Never-Ending Bull Market: Beware! We use  investor sentiment indicators as contrarian gauges on the direction of the stock market. That’s because most investors historically make decisions detrimental to their financial well-being. The numerous sentiment indicators we follow overwhelmingly have been warning of an impending downturn as investors remain stubbornly optimistic.  That’s despite all the historic warning signs that stocks are extremely overbought. Added to that is the present grave economic uncertainties which could cause a major market reversal.

As you can see from the charts below, the recent downturn instead of rightfully instilling fear, has been treated by many investors  as a ho-hum event that triggered an increase in bullish options strategies, including an increase in call volume. This foolhardy  strategy leaves these  investors unhedged and greatly exposed in the event of a downturn. And, it is yet another affirmation of our strategy as contrarians to move heavily into cash in our Active Alts SentimenTrader Long/Short portfolio. Which seeks superior long term appreciation while minimizing risk.  Moving into cash preserves gains in stocks with considerable appreciation, gives us the ability to short weak stocks during a downturn, as well as buy stocks near the next bottom.

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Higher and Higher Levels of Bullish Stock Market Sentiment are Getting Downright Scary. We use investor sentiment gauges as historically accurate contrarian indicators  of  the direction of the stock market. So, what’s raising red flags for us is this week’s poll of more than 100 newsletter writers from SentimenTrader. FYI, SentimenTrader supplies the research to determine  market exposure for the Active Alts SentimenTrader Long/Short portfolio  that we manage. SentimenTrader’s poll shows the bulls edged higher to 61.5%, from 60.0% last week  as a few more editors increased their exposure to stocks. That is a new high for 2020 and the most bulls since September 2018, which was at 61.8%. Bullish sentiment above 55% bulls calls for defensive measures – tight stops at the minimum and possibly some selling among shares with big gains. Bulls at 60% and above signal increased danger the higher they get, and the need to prepare for a market decline The bears barely changed at 16.4%, up fractionally from their 2½ year low at 16.2% a week ago. “Most of the bears have missed the five month rally. Now they remain on the sidelines, suggesting a major decline is near, “ says SentimenTrader.

SentimenTrader points out that the current bullish levels are up substantially from just 30.1%, shown near the market lows of March 23. That was the fewest since Dec-2018 ended with a similar 29.9% count. Bulls near 30% say cash is high after a market tumble for a lower risk buying chance. Those signals for market bottoms occur much more quickly than indications for market tops. As you can see from the chart below, the bull-bear difference moved further into the danger zone at +45.1%, from +43.8% last issue. We should mention sentiment top signals can take months before markets decline. However, they also keep intelligent traders from waiting too long and watching gains turn to big losses. So, the bottom line for us is that we’ve moving into cash because we have a long/term, short/long strategy to minimize risk and maximize profitability. 

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Why Our Active Alts SentimenTrader Long/Short Portfolio has Raised  Cash.  Many of the tools that we display weekly are actually used in our money management business, www.ActiveAlts.com .  We use sentiment gauges of all kinds to help determine risk/reward.  Active Alts and SentimenTrader have created an unleveraged long/short strategy called Active Alts SentimenTrader L/S Strategy. The strategy uses SentimenTrader’s world-renown  research to help determine the long/short exposure, while Active Alts manages the strategy. We should note that the long/short strategy is 100% powered by SentimenTraders’ research and Active Alts proprietary  stock selection. We use SentimenTrader’s compilation of its indicators as a contrarian gauge for  market direction to help determine exposure. Based on those indicators, we have raised  cash.

Here’s why!  As you can see from the chart below,  the compilation of indicators recently has become excessively optimistic. In fact, the percent of indicators showing excessive optimism is now at a very high 52% while indicators showing pessimism have tumbled to a very low 8%.  From a contrarian point of view, that excessive optimism and low pessimism is a strong signal for a market reversal since investor sentiment is usually wrong.  You’ll note in the chart  that the last time these excessive bullish and weak bearish levels occurred was earlier this year just before the Covid-19 pandemic sent the stock market tumbling.  There’s no way of determining exactly when a sharp reversal will occur. However, our move to raise cash  serves as a hedge against a market tumble. At the same time, the move from stocks to cash preserves strong gains from the recent market upsurge. Moreover, when SentimenTrader indicators signal  the next near bottom we will be in a strong cash position to buy low and reap substantial returns as the market moves up.

A bottom.

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