Are We In For A Stock Market Correction As The Euphoria Is Reaching Its Peak Ahead Of A Market Top

by Umar Farooq

Ever since President Trump has taken oath of the office, investors have been pushing major stock indexes to record highs on the bet that new administration will roll back financial regulations, cut taxes, and increase fiscal spending, all of which could help boost profits in corporate America. However, many investors are getting worried that high expectations could lead to major disappointment.

The share of newsletter writers who are optimistic on the stock market climbed to 62.7% this week, the highest level since 2004, according to Investors Intelligence, which surveys more than 100 newsletter writers each week for its Sentiment Index.

The gauge has become something of a contrarian indicator. It tends to reach peak euphoria ahead of a market top, and pessimism typically peaks at market bottoms. It’s one of a number of sentiment measures, including ones for consumers and small businesses that have shown optimism spiking since the election. The surge in positive sentiment is increasingly out of step with an economy that is improving slowly.

A reading above 55% suggests a trading top is forming, while topping 60% means “it is time to start taking defensive measures,” according to Investors Intelligence.  The measure has been above 55% for 11 straight weeks, and above 60% for four of them.

But the firm warns that as a contrarian indicator, it’s more useful in calling market bottoms than market tops, particularly since market tops can form over time. The market bottom worked at the beginning of last year. Bearishness was elevated far above bullishness in mid-February, when the S&P 500 bottomed after falling more than 10% to start the year.

Investors look at it as a useful signal. Ed Yardeni, chief investment strategist at Yardeni Research Inc, said he looks at the ratio of bulls to bears in the survey, and noted that the reading of 3.75 this week was well above the level of 3 that’s generally seen as a sell signal. Back in February of 2016, the reading of 0.63 had been a useful buy signal.

“We are due for a correction,” Mr Yardeni wrote in a Thursday report. “Such panic attacks followed by relief rallies have been the modus operandi of this bull market since 2009.”