As the markets continue their historic move off the Christmas lows, some sentiment indicators have moved solidly into the bullish camp. That’s great news, right? Well, mostly. It could also signal excess complacency, which could lead to a pullback in our near future. Let’s unpack the possibilities.
What sentiment indicators are saying
The VIX closed last week under 13%, the second time it’s closed this low over the past month. That complacency could lead to a corrective move upward in volatility, which will scare just about every bull in town. However, the overall trend in volatility is down, so this is a good opportunity to scoop up stocks. Keep some cash handy.
Several polls, including AAII, Investors Intelligence and the Fear/Greed Index, show an increase in bullish sentiment. These are important readings, as they act as contrarian indicators. Put/call ratios, a measure of bullish/bearish balance, has steadily gone lower, which tells us more buyers are piling in. When this indicator is too low, it’s a bad sign.
As we have mentioned before, new highs/new lows is an important indicator of a market rally’s health. In September and early October, this indicator fell apart, just as the markets were reaching for new all-time highs. That divergence ended poorly and culminated in the breathtaking selloff in October and December. This indicator works best at extremes (you want to see it making highs when markets are also making highs, and vice versa). Right now, new highs/new lows looks good.
Finally, breadth. A strong breadth thrust indicator launched us into January, and it has been the key to this rally. We recently saw a small corrective move, but now breadth is back on track. Even the broad Russell 2K enjoyed strong breadth last week. This tells us any pullback is likely to be shallow (barring any news or events).
These bullish signs don’t change overnight. Therefore, I don’t see a major breakdown or pullback happening any time soon.
