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Investor Sentiment Suggests Stock Market Nearing Danger Zone

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).

Investor Sentiment Suggests Stock Market Nearing Danger Zone
Investor Sentiment Suggests Stock Market Nearing Danger Zone

Our conclusion? Remain cautious.

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Brad Lamensdorf

Brad Lamensdorf, the founder and portfolio manager of Active Alts, is a principal and co-manager of the AdvisorShares Ranger Equity Bear ETF. He previously managed a long-short investment partnership from 1998-2005 under the name Tarpon Capital Management. Earlier in his career Mr. Lamensdorf was an equity trader/market strategist for the Bass Brothers’ trading arm. He managed a short only portfolio in addition to co-managing a $1bil hedging program. He also served as in-house market strategist for the entire internal and external network of Bass Brothers money managers.

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