Popular Sentiment Indicators And How I Use Them

At the end of
1999 and the beginning of 2000, the Nasdaq was cooking. Biotechs,
Internets and Technology
seemingly could not be stopped. Bullishness in the market was running
rampant. Investors’ expectations were sky-high and rising. Analysts had
recommendations with targets of four figures. Newsletter writers were telling
you to back up the truck.

Fast forward to February
2001. The Dow and S&P 500 had
sustained intermediate-term corrections. The Nasdaq was
down a whopping 53% from its March 2000 high. Many famous tech names were
down more than 70% and a bunch of Internets had
already said bye-bye.

You would have expected them
to have much less optimism in the markets. In fact, you would expect downright
pessimism. But
these talking bulls hadn’t
budged. One of the most popular gauges of sentiment and my favorite comes from a
company called Investors Intelligence. This company tracks newsletter
writers. Many years back, Investors Intelligence decided to follow these
writers’ opinions in order to decipher which way the market was headed. They
figured that if all these writers were bullish, it would be a good sign to be in
the market. Were they in for a surprise? After years of study, they found the
polar opposite was true. It turned out that these writers were trend followers
and would only turn bullish or bearish after the move.

Thus, I
consider the bullish newsletter number a great contrarian indicator. In
the past, when optimism has
gone to extremes, it often
preceded market tops. When pessimism hit extremes, it often
signaled a bottom. While 55% bulls would appear
to me to be a worrisome number, 35% bulls would be
time to consider buying. Most people believe it is a mistake to watch
these numbers. I disagree.
While I will always believe market action holds the most weight, when these
numbers go to extremes, they have worked quite well for me as a secondary
indicator of
where the market cycle might be.

Here are some facts to chew on:

1. Throughout the major
   drop of March
   2000 until February 2001, the newsletter
   writers stayed steadfastly bullish. At
   the beginning of February 2001, and not so coincidentally after the move up,
   the bulls hit 61.8%,
   which is a
   14-year high. I
   viewed
   this as a worrisome
   number.

2. In 1994, just before the market
   kicked into gear, bearish sentiment hit 59%.

3. In 1990, during the recession, more
   than 55% of the advisors were bearish. The Gulf War started and the market
   never looked back.

4. In 1987, 61% of advisors were
   bullish all the way into October. I don’t think I have to refresh your
   memory as to what happened next.

These are just a few moments in
history when these numbers went to extremes. Keep in mind, these extremes do not
happen very often. I urge you to start paying close attention to this indicator,
as it has
been very uncanny when
extremes have occurred.

You can find this number every day on
the market page of Investor’s Business Daily.

Look for my next
report where I will discuss put/call ratios, magazine covers, short interest
and other sentiment indicators.