I still believe that market sentiment matters but in the current environment it matters less than usual. It takes larger extremes in bullish sentiment to knock down the market when there is an underlying bid from corporations. I believe that we are nearing a point where sentiment is extreme enough to matter. The vast majority of the sentiment indicators I track are now urging caution and the market is stretched:
- Investors Intelligence bears are below 20% while the bulls are at 54%
- Newsletter writers tracked by Hulbert are recommending the largest long position in stocks since January 2002.
- Rydex traders are positioned at a bullish extreme
- Investment advisers tracked by NAAIM stock exposure remains at the upper end of historical allocations.
- The most speculative of stocks are flying.
- Margin debt is nearing record levels.
While sentiment has not mattered all year there are now a confluence of indicators in extreme territory. At the same time breadth has been lagging in recent days. If sentiment still matters at all this should be the time when it asserts itself. Normally, I would expect an intermediate term top under these conditions. But with the underlying bid from corporations still present I would not be shocked to only see a shorter term correction. I am expecting a 3% to 5% pullback at a minimum leading me to take a net short position in the market.