Sentiment hitting bullish extremes = reversal imminent

I think sentiment is reaching bullish extremes in the midst of strong distribution from the smart money. In addition, the market is blowing off in the midst of global good news, which leads me to believe that we'll reverse tomorrow or Friday to end the week much below SPX 1080, and likely not make a new closing high.

It's quite amazing actually: there's usually a mix of bullish and bearish bloggers, but at turning points it's really interesting to notice how everyone, even the previously bearish people, switch to attempt to trade "one more rally before the turn." Here's my analysis of the blogs I follow (see links on sidebar):

Carl Futia: normally bullish, currently looking for a rally to 1120
George Rahal: switched to bullish at the Friday low (nice!) but looking for new highs
Kevin's Market Blog: was cautious at end of Sept, but is now looking for retest of highs
Bespokeinvest: neutral
Slopeofhope: bearish, but only 10% short, waiting for that final pop to enter fully
Elliot Wave Lives On: had a mostly bearish wave count, but switched to more bullish wave count today
Gary's Common Sense: cautiously bullish
Evilspeculator: just capitulated his bearish position for that "one last rally"
X-trends: normally ultra bearish, but now open to possibility of a bull-orgy climax

To sum up: nearly everyone is on or has jumped on the "one last rally" boat. Take a look at this chart below that shows investor pain (from www.marketpsych.com):

We're not even at new highs but everyone is happy to enjoy the expected ride to above 1080, at which point they'll sell. I guess I'll be on the other boat and say that we're not going to new closing highs.

The second point is that this rally is terminating on good news. In fact, the rally from Friday's low has been ignited by Australia. On Monday, they raised rates, and today they reported job growth vs. job losses. Sounds bullish, right? Take a look at the AUD/USD chart below:

This 20-y chart looks bearish to me, as we're retesting the trendline that was broken to end the 8-year uptrend. This leads me to believe that we're witnessing the end of the rally coming on the good news. You can see the same thing on the long-term SPY chart below:

Again we're hearing all this great news about the global economy about how things are getting better. However, all I see is that we're retesting the bottom of a 20-year uptrend that was finally broken last year. Notice how volume increased on the decline and has decreased on the rally?

Finally, in the midst of the bullish sentiment and "strong recovery," we're seeing strong distribution by the strong hands. Check out the daily chart of SPY below:
We have 5 distribution days in the past month, indicative of strong selling by the market drivers (institutions). William O'Neil (founder of IBD) correlates this with a high possibility of a trend change. This indicator has worked very well in the past for me, probably 4 out of 5 times. In addition, we're retesting the underside of the uptrend that began in mid-July.

All-in-all, we're seeing excessive bullishness in the midst of distribution and good economic news. I will aggressively short any rally, and I do not expect the market to make it much higher from here.


Anonymous said...

Refreshing! Thanks for your observations.

Anonymous said...

Excellent post!

Anonymous said...

been watching the volume too

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Anonymous said...

Oscar's OMNI (delayed) update for trade day 10-08: Go long /ES mid 1050's. Expect resistance mid-high 1060's and low-mid 1070's. Possible target 1080's if bulls get really hungry. Close all by EOD. "Stops Are In -- Emotions Are Out!!!"

dxo said...

I concur with your conclusion. Too many people expecting 1100 now.

seeer said...

After all, the shorties are the best buyers!
Keep it up!

Wes said...

Solid analysis, but I think that flatter trendline you drew on the 20-yr is a bit erroneous compared to the flatter, downsloping line on across the various highs, which you didn't draw but is now strong support. Perhaps we'll see downside until a possible retest of that support...