What do you get when you cross an overbought market with too few bears? Often, that combination of complacency leads to a correction. So far, all it has produced is a lot of frustrated contrarian traders.
Stephen Suttmeier, technical strategist at Merrill Lynch, put the situation into broader context in his monthly chart book over the weekend:
As of October 25, Investors Intelligence (II) % Bears extended deeper into contrarian bearish territory below the 20% level with a reading of 16.5% … down from 18.5% the prior week and the lowest level for II % Bears since April 2011 – this suggests too few bears among newsletter writers … However, given the strong trend for the equity market as well as bullish volume (VIM & VIGOR), market breadth, weekly momentum and seasonals, we favor a rally into year end and expect pullbacks to be limited.
I spoke with Merrill’s MacNeil Curry this morning. He noted that while there may be too few bears, sentiment is but one factor in the overall market equation. The other elements are fairly positive: We are now in the seasonally best half of the year, market trend has been strong, and the momentum and volume have been constructive. Most notably, market breadth — the number of stocks advancing relative to the decliners — is very positive.
Merrill’s technical team is looking to take advantage of any pullback. Today’s red screens just might be the start of that correction. They expect it to be relatively shallow, and would suggest adding to equities to be positioned for an expected year end rally.