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.

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