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Animal spirits

 

S&P's sideways grind

 

Both on Wall Street and over here, I see the action as pointing to more gains. The sell-off has been inconsequential compared to the rally that went before it. Seasonality has turned positive, while the internals of the market, like breadth, are robust. In response to my column on breadth last week, James Goss emailed to ask whether breadth in London was in as good nick as in New York. The answer is yes: the latest high in our own FTSE 100 was accompanied by a fresh peak in its advance-decline line.

 

FTSE's perky breadth

While all this bodes well for a good final few weeks to 2013, I'm a bit unsettled by how many other pundits are saying the same thing. The latest Investors Intelligence survey shows that 52.6 per cent of US tipsters are currently bullish with just 15.5 per cent bearish, a gap of 37.1 per cent. When the gap is above 30 per cent, it's often seen as a mark of over-enthusiasm, and supposedly heightens the risk of a pull-back in the US market.

 

Jubilant pundits

 

The theory is that with so many folks already bullish - and presumably therefore already long - there's no little new money sitting on the sidelines that come into the market and drive it higher still. As one newsletter writer, Bert Dohmen of www.dohmencapital.com puts it, "when everyone is in, the markets can only decline. At a top, everything looks wonderful".

It's certainly true that pull-backs are much more likely when sentiment gets bubbly. The bulls were 30 per cent ahead of the bulls just before Wall Street plunged in the spring/summer of 2010, for example. But sentiment surveys are a blunt instrument: they seem to tell us little or nothing about the timing of the coming pull-back.

There have been times in the past when the gap between bulls and bears has stayed above 30 per cent for long periods. For example, it went above there in May 2003 and remained there until mid-March 2004! Had you shifted to the sidelines when the reading first went above 30 per cent, you'd have missed out on a gain in the S&P 500 of some 25 per cent.

 

Overbullishness, 80s style

 

The obvious response to this is that 2003-04 was the early part of a new bull market and, as such, a long spell of bullishness was less worrisome. However, it is not unheard of for sentiment to stay starry-eyed for months on end much later on during a bull market. This is what happened in mature bull market years like 1986, 1987 and in 2006 and 2007. Ultimately, the market did tank in these cases, but only after extended periods of very tradable upside.

In conditions like these, it is especially worth listening to those rare souls with a different viewpoint to one's own. This week, I therefore did a video with Brian Whitmer, an arch-bear from the Elliott Wave Institute. His predictions are truly chilling; you can hear them here: http://bit.ly/1cQEuXy. As requested by some readers, we'll shortly be publishing an article around his comments.