Here's one good reason why: a historic market sentiment extreme
By Elliott Wave International
The DJIA, S&P and NASDAQ are struggling to bounce. Yet the bullish convictions remain high. Says a February 5 Investor's Business Daily headline:
"Why Mutual Fund Investors Need Not Panic After January Sell-Off"
When is the best time to get out of the stock market? When everyone else is invested and extremely optimistic. When is the best time to buy, then? Exactly: when you see the opposite sentiment.
Market sentiment is one indicator you don't hear much about on financial networks. Yet we've seen sentiment extremes repeat at every recent market top and bottom. What's more, as Robert Prechter, the president of Elliott Wave International, puts it, "the greater the degree of the advance that is ending, the greater the optimism at its peak."
This contrarian view of the market can be a financial lifesaver.
Below is an excerpt from Prechter's recent Elliott Wave Theorist, a monthly newsletter he has published since 1978. It shows you one way how Bob finds bearish and bullish extremes in the market.
Conviction Among the Bulls
(Robert Prechter, The Elliott Wave Theorist, December 2013)
The Daily Sentiment Index (trade-futures.com) reported 93% bulls twice, on November 15 and 22. Two readings this high are a rarity.
The weekly Investors Intelligence poll on December 11 and 18 showed over 80% bulls among committed advisors (i.e. bulls/(bulls+bears), omitting those expecting a correction), the highest reading since 1987.
Such extreme readings in conjunction are even rarer.
The Rydex family-of-funds data afford good sentiment indicators. Recent figures show a record low investment in conservative money-market funds, meaning nearly everyone is invested in stocks and bonds.
At the same time, the ratio of money in bullish stock funds vs. bearish stock funds is over 5:1, and per sentimenTrader.com the ratio of money in leveraged bull vs. bear funds (see Figure 2) is 10:1!
This reading leaves past extremes in the dust. If you study Figure 2, you will notice that the biggest rush has come in the past six months, which is precisely the time that stocks' ascent has been slowing!
In other words, optimism is soaring while upside momentum is waning.
Once this epic complacency melts, I doubt we will see such a ratio again in our lifetimes.