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Equity Strategists Call for a Market Rally - Should you Bite?

Chad Karnes

Put your money where your mouth is, the popular saying goes.  When an opportunity is apparent people act on it, and it is this theme that is behind sentiment analysis.

Sentiment analysis looks at people's opinions, suggestions, and actions in an attempt to discover their true beliefs.  An analyst that is bullish on stocks, more often than not, would be long stocks, putting his money where his mouth is, and already invested.   A bearish investor would likely be short and/or sitting on the sidelines.  By looking at their opinions and actions, an investor can gain an edge.

Sentiment analysis is typically contrarian in nature, and here is the kicker, it quite often works.  Here is why:

Sentiment using Apple and the Dow

If you are like me, you probably have had countless conversations with friends about why Apple is (or is not) a great buying opportunity.  When that friend tells you they are bullish Apple's stock (AAPL - News), a red warning flag should instantly trigger in your mind, though.  Most likely they already own Apple's stock, and that is important.  Everything they now say about Apple must be taken with a grain of salt as it is apparent they have a vested interest in seeing Apple's price go up.

It would be against their primary goal for owning Apple's stock to tell others they are bearish and to short it, regardless of whatever potential evidence presents itself.  This is the premise behind Sentiment Analysis.  Your friend is invested and bullish and likely will always be as long as they own the stock.  Their vested interest requires them to be.

Here is how Sentiment Analysis can give you an edge:

If you are long the Dow Jones Industrial Average (^DJI - News) and want the price to go up, just like your friend with Apple, you try to convince the world why it should.  Once a lot of investors do the same thing, eventually sentiment data will show us when there is an inordinate amount of bulls trying to convince the world to be long stocks.  It has now become a crowded trade.  In a nutshell everyone is already invested, has a vested interest in price going up, and thus there is very little money on the sidelines left to propel prices higher.  Everyone has already bought.

Popular Sentiment Data

Some of the more popular sentiment outlets involve surveys of investment newsletter and advisory services such as Investor's Intelligence.  Another popular sentiment measure is the Consensus Survey which measures hundreds of brokerage analyst and independent advisory service client recommendations.  The non-profit AAII (American Association of Individual Investors) Survey polls its Individual Investor members who typically use a longer-term fundamental approach for their investments.  Still other sentiment surveys include the NAAIM, MarketVane, Hulbert, TIM Group, and Delta Tactical.

When their surveys reach extremes, trades are likely crowded.

Each month in the ETF Profit Strategy Newsletter, we dive into all of the sentiment data available, some of which is displayed below and was provided on 8/17.  More objective S&P data such as the VIX (VIXY - News) and put/call ratios have already reached extremes, and some of the more subjective surveys are also now flirting with extremes after this week's stock rally.

Another example, Silver (SLV - News), after its 20%+ gain in under a month, is currently reaching sentiment extremes, too.  

Wall Street Strategist Sentiment

In last week's cover story in Barron's, titled 'Tough as Teflon', Wall Street Strategists weigh in on why they have their 2012 S&P 500 (IVV - News) forecasts averaging 1446.  These strategists make up the largest money managers in the country working for firms such as Blackrock, Goldman (GS - News), Barclays, Citigroup (NYSE:C), JPMorgan, Merrill Lynch, and Bank of America (BAC - News).   

Given what we know about sentiment analysis, do you think they were already long or short?  After Thursday's, 9/6,rally, the S&P is looking more and more like it wants to reach 1446 (or perhaps beyond), but should we expect it to stay there, and what will these strategists likely do now that 1446 is within reach? They may have gotten what they wanted this time,more bulls raising their investment prices, but when an extreme in sentiment is hit, it likely is time to lighten up.

It is important to note that they all are still bullish on US Treasury Yields (TLT - News) with an average 10 year yield (ILF - News) target around 2.0% as the 10 year currently fluctuates around only 1.65%.  They were bearish on bonds and wrong last year and are again so far this year.  Do you think they are already short treasuries?  My vote is no doubt, and they want you to help them get to 2.0%.

The ETF Profit Strategy Newsletter monitors global events and market conditions to formulate actionable profit strategies across multiple asset classes based on sentiment, technical, and fundamental research.

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