The stock market is like a crowded canoe. If enough people in the boat lean far enough over the same side, you’ll see a swift reaction.
That’s why sentiment surveys are so useful. If you can gauge exactly when opinions begin to shift toward extreme levels, you can plan to play the snapback move no one else saw coming…
There are a ton of sentiment gauges out there. But many of them — such as consumer confidence — are a more useful measure the economy, not the markets. So if you’re looking to find out how the market will probably react in the short-term, your best bet is to find out what newsletter writers are recommending.
This is not a sales pitch. You’ll see why in just a second…
Here’s a chart showing 10 years of newsletter sentiment compared to the S&P 500. Whenever the sentiment reading pops above 70%, the broad market has pulled back to some degree on a consistent basis. As of the most recent reading, bullish sentiment is topping post-financial crisis highs.
So unless newsletter writers have all bought new thinking caps, their bullish recommendations point to a correction in the near future. That’s right — it’s not a bad bet to go against newsletters when most of them are in agreement.
The folks at sentimenTrader have the stats:
“There have been a total of 9 weeks when the combined level neared 70% (a couple of them were clustered together). A month later, the S&P 500 showed a negative return every time, a median of -3.1%. Its maximum gain during the next month averaged only +0.1% (using weekly closes) while the maximum downside averaged -4.4%.”
As you can tell from the gauge, newsletter writers can be a fickle bunch (reserve your judgment — I might know one or two). The needle can swing between extremes a few times a year…
Even so, this is one gauge worth watching should the market continue to melt up. I’ll keep a close eye on any new developments in the coming weeks.
for The Daily Reckoning
Greg Guenthner, CMT, is the managing editor of The Rude Awakening. Greg is a member of the Market Technicians Association and holds the Chartered Market Technician designation.
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