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Are Bullish Extremes Pointing to a Market Peak?

Apr 08, 2013
Chad Karnes, CMT

Stocks sold off last week, but is this just another opportunity for dip buyers? Our analysis suggests that we are likely a lot nearer a market top than a market bottom. We are watching a few key support levels to confirm a trend change and protect longs.

If you’ve read any of my articles before, you know that I like to scan the headlines to gauge the public’s “mood of the moment”.  I like to have a pulse on the media’s outlook because it can provide valuable clues to the market’s future.

Here are some of the headlines featured last week:

“Jobs Data Misses but the Recovery Lives On”
“The Commodities Selloff is not a Sign of Global Slowdown…and it’s Good for Stocks”
“Money Spigot Opens Wider (concerning Japan)”

The first two articles feature popular money managers who suggest that investors find the silver lining in the otherwise ugly employment report and recent commodities selloff.  The final headline speaks to the ongoing worldwide stimulus being put into effect and how that is good for equities.  Most headlines certainly have a bullish slant, and they certainly do not represent "a wall of worry".

Dissecting Headlines

When I read these headlines and articles, the contrarian in me perks up.  Let me explain why.

The first two articles feature prominent money managers whose primary purpose is to grow assets under management.   This means they have a fiduciary duty to try to keep you invested in stocks, just like most of Wall Street.  Should we really trust their “expert” opinions given their blatant conflicts of interest?  My guess is they were singing a similar tune in 2000 and 2007 as well, just before the markets tanked.

The final headline speaks to the recent Japanese central bank’s plan to release “an entirely new dimension in of monetary easing”.  This one is easier.  If things are going so well, why then do we need all this easing?

We need better indicators than the "news".  Luckily we have them.

Bullish Sentiment Extremes

Last week (April 1), the market had recorded a number of bullish sentiment extremes. The most notable was the CBOE Equity Put/Call Ratio, which fell to its lowest levels since March 2012 - which was when the last prominent stock market peak occurred.

Bullish sentiment as captured by the II poll and a plethora of other polls also are now at their highest levels since April 2011.  The bullishness as measured by these indicators are even approaching or already reached their all time high readings.  In fact, the percentage of bullish advisers and investors is as high now as it was in the fall of 2007, right before the previous major market collapse.

The VIX (Chicago Options: ^VIX) also is near its six years low, showing signs of extreme complacency.  Couple all of these sentiment indicators and we have the recipe for a potential major market top.

The table below, featured in the ETF Profit Strategy Newsletter on March 22, neatly summarizes the various sentiment indicators. The Newsletter’s simple conclusion was that expectations are so good, it’s actually bad.  The data “paints a pretty clear picture that sentiment is near or already exceeded the bullish sentiment extremes associated with the recent major market tops.  As we often like to say, the market has legs, but no brains”. 

In addition to the summary below we included over 20 more indicators showing similar sentiment extremes along with historical references (the rest are reserved for subscribers).


Support Levels

Sentiment gauges are valuable, but basing decisions merely on sentiment can be dangerous, and basing decisions on fund managers who likely don’t have your best interest in mind is downright deadly.  For that reason, the ETF Profit Strategy Newsletter also looks at important support/resistance levels to help warn of market trend changes.

Here are some of them mentioned in Sunday's (April 7) Profit Strategy update:
1) A trend line originating at the Nov 2012 lows 2) Fibonacci support levels 3) Nearby Support and Resistance levels 4) January’s price peak and why it’s important 5) Elliott Wave 6)Weekly pivot support

The Update recommended to close out long positions (established when the S&P reached the Newsletter’s upside target at 1,570) and start to entertain short positions as soon as the S&P falls below $15XX (reserved for subscribers).  Friday came close and a continued decline will likely suggest a longer term change in trend from up to down is upon us.

How Low Could it Go?

The key question now is whether this selloff is merely another opportunity for bulls to reload or have we actually reached the point of exhaustion for bulls.  Sentiment certainly suggests such an exhaustion scenario could be in play and our assessment made on March 22 was that: "Risk Remains Elevated.  The Upside Expectation Seems Very Limited but the Downside Risk Large. "

If the S&P 500 (NYSEARCA:IVV) falls below that key support of 1,5XX, “at a minimum, a correction of the entire move up since November is expected (a pullback to 1500/13,800 at a minimum), but potentially a lot more”.

The ETF Profit Strategy Newsletter delivers complex technical analysis in an easy to understand manner. Knowing important support/resistance levels gives traders and investors the edge needed to outsmart the market.

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