Why Sentiment is Beginning to Shift

That didn’t take long.

Just last week we looked at the chart of the S&P 500 and figured it was likely headed towards the 4300 level.

And, here we are…

The index closed Tuesday at 4284 – within spitting distance of the high from last August.

Investor sentiment – a contrary indicator – has been quite bearish for the past several weeks.

And, that bearishness has helped provide fuel for the market’s rally. Now though, as the market approaches its highest level in a year, sentiment is starting to turn bullish.

You can see it in the CBOE Put/Call ratio, which compares the volume of puts traded to the volume of calls. The ratio fell to 0.76 last Friday – meaning the number of call options traded was 24% higher than the number of puts.

That was the lowest reading since just before last Thanksgiving. And that happened within days of the market hitting an intermediate-term top.

In other words, a lot of the fuel that was available (in the form of contrary investor sentiment) to push stock prices higher has been spent. That makes it more difficult for the market to rally even more from here.

Here’s something else that will make it hard…

The Volatility Index (VIX) is on the verge of generating a sell signal. Look at this chart…

The Volatility Index closed below its lower Bollinger Band and at its lowest level of the year yesterday. The index will generate a broad stock market sell signal when it closes back inside the Bollinger Bands.

This will mark the fourth VIX sell signal of the past year. All three of the previous signals occurred within just a few days of intermediate-term tops in the stock market.

The S&P 500 fell 700 points in two months following the VIX sell signal last August. The index fell 200 points in six weeks after the November sell signal. And, the S&P fell 200 points in six weeks following the VIX sell signal in January.

If a similar pattern plays out this time, the S&P 500 could be trading near 4100 by mid-July.

That’s not a huge decline, and it doesn’t warrant taking an overly aggressive bearish stance.

But it is enough of a move to justify some caution when entering new long-positions in the stock market. And, it could yield a nice gain for traders who make a well-timed short trade.

Best regards and good trading,

Jeff Clark

Are you positioned to short the market?

Let us know your thoughts – and any questions you have – at [email protected].