Investor sentiment is a contrary indicator, which means that stocks generally deliver their best returns following periods of deep pessimism. Institutional investor sentiment started to recover from record levels of pessimism quite quickly following stocks' March 2009 lows, and returned to elevated levels of optimism by last summer where it remains. However, individual investors remained more cautions until recently (see Weekly Chart). The persistence of the stock market's uptrend combined with clear evidence of a robust recovery in corporate earnings has finally persuaded individual investors to become more optimistic. Ironically this will likely make further gains over the short term more difficult to achieve.

Phil Roth, a founding member and former president of the Market Technician's Association, succinctly framed the purpose of technical analysis: rather than predicting the future, technicians "assess the trend and advise appropriate actions." In that light, from a technical perspective, we assess the stock market's uptrend as still intact. The S&P 500 has made a consistent pattern of higher highs and higher lows since July's bottom, which itself was a normal 24% retracement of the cyclical bull market's initial rally from the March lows. Furthermore, stock market measures of breadth - advancing issues versus decliners and stocks making new highs versus those making new lows - suggest relatively broad participation in the uptrend over the past six months and should support the trend's durability.

Thus two out of three of our investing rules, don't fight the trend and don't fight the Fed, remain positive for stocks while only the third, beware the crowd at extremes, is signaling caution. With stocks around the world in clear primary uptrends and global monetary policy supportive, we do not expect investor sentiment to de-rail the current cyclical bull, but we believe elevated levels of optimism are a headwind and make corrections more likely.

David Fuller's view The Weekly View also contains an interesting item on Chile, a market that Eoin has commented on previously and by coincidence, does so again below.

What about the three investing rules mentioned above?

We think they are very important, as veteran subscribers may recall.

Investor sentiment is the most difficult to monitor, although our sister firm Investors Intelligence does a good job of it with their renowned Advisors Sentiment indicator which we featured on a number of occasions, coinciding with the stock market's bottoming out process in 2008-2009. Here is the latest picture and also a paragraph from their latest commentary:


After reaching a twenty-six month high at 53.4% last week, the latest data showed the bulls moving down to 52.4%. In October 2007 we counted the bulls at 62.0% as the averages were achieving their all-time highs. Caution is signaled when their number reaches 55% and readings around there are indicative of a major market top.

Rod Smyth and Co are commenting on individual investors' sentiment as measured by Ned Davis Research. Considering these two indicators, I would agree that they are a growing concern for US stocks and therefore most other equity markets due the Wall Street leash effect.

Also, you may have seen Eoin's comment on weekly keys (Email 2) posted on Monday, which I also mentioned in that day's Audio. We believe that a consolidation of the yearend and early January gains has commenced. This is a normal and healthy process, provided that the uptrend characteristics are not eroded, which takes us on to the rule:

Don't fight the trend. So far, the S&P 500 Index's trend shows an unbroken progression of higher highs and higher lows since the June to early-July correction was completed. Of these, the higher lows are considerably more important for our monitoring purposes because the market cannot experience a significant correction, let alone provide evidence of a major top, without first breaking its uptrend consistency. Currently, the first clear evidence of deterioration for the S&P would be a close for more than a day or two beneath 1085, which is the lower side of that narrow trading range formed from mid-November to mid December. However, were this to occur anytime soon, the S&P would still be above its rising mean, represented by the 200-day moving average. On to rule three:

Don't fight the Fed. I have often said that monetary policy generally trumps other factors most of the time. Therefore this third rule is arguably the most important of all, in my view. However, it is usually a lead indicator, as is sentiment, so both need to be evaluated in the context of the market's primary trend.

In summary, I regard increasingly bullish sentiment as an amber caution light. It is amber rather than red because the crowd is far from euphoric, in my opinion. Many bulls say that having seen the recovery from an oversold extreme, we can now look forward to an extended phase of earnings growth. They need to be right if this is to be a lengthy bull market. Monetary policy has never been more accommodative and presumably can only become less so, as we have already seen with China and a few other markets. Stock market trends will show us when supply eventually gains the upper hand in what remains primarily a demand dominated environment. On balance, we remain bullish, but become steadily less so as more of the upside potential is fulfilled.