Is the market too optimistic?
The most recent survey by Investors Intelligence reports a market bull/bear ratio of 4-to-1. That’s the highest it’s been all year, close to the peak of 2013 and approaching levels not seen since early 1987.
“Typically, when there’s too many bulls in the market, the market tends to be due for a setback,” explained Ari Wald, head of technical analysis at Oppenheimer & Co. “Vice versa, you want to buy when there’s not a lot of bulls. So the fact that there’s four times as many bulls is bearish.”
The fact that the bull/bear ratio is near its highest levels since before the ’87 crash is a warning sign for stocks, said Wald. “Usually when you get these types of readings, some sort of consolidation is due.”
But here’s the strange thing: Wald is bullish. “We think sentiment is much more fragile than this sentiment’s suggesting.”
Wald notes that the Investment Company Institute reported the largest domestic equity mutual fund redemption since 2014 began and the 10th-straight week of outflows.
“I think these bulls are going to get shaken out in a hurry, much like February, much like April of this year,” Wald said. “If you get some volatility, the bulls fall, [and] I think those are your buying opportunities.”
Wald’s trading strategy is to offset volatility by playing large cap versus small cap stocks. “We want to stay long on the S&P 500, and we want to short the Russell 2000 against it,” he said. “That’s the way to neutralize against some upcoming volatility while still sticking with the stronger areas of the market.”
However, Gina Sanchez, founder of Chantico Global, thinks the market has been ignoring too many troubling sign on its way to new heights.
“We have seen a number of worrying conditions building up in the market as people have sloughed off poor economic numbers, sloughed off poor earnings, [and] sloughed off negative guidance,” said Sanchez. “How many of those things can you refuse to listen to until at one point, you’re faced with a market that may not be able to generate the kind of earnings you’re expecting?”
Sanchez, a CNBC contributor, notes that about three-quarters of the companies in the S&P 500 have issued negative guidance, based on data from FactSet. And, she sees one major reason why earnings have been growing despite lackluster top lines.
“One of the things that has been really helping earnings hasn’t been revenue, it has been stock buybacks,” Sanchez said. “The largest companies in the S&P have been buying back their stocks, and…that number is starting to plummet.”
“All of these things give me reason to worry,” she added. “I don’t see this as a positive. I think this is definitely a negative indicator.”
To see the full discussion on the S&P 500, with Wald on the technicals and Sanchez on the fundamentals, watch the above video.