Jason Goepfert at SentimenTrader—the definitive source for sentiment data on stocks, bonds, and commodities—has been tweeting out a few warnings signs regarding “excessive optimism” in the stock market, so we decided to have him back on Financial Sense Insider for an update.
The last time we spoke with Jason Goepfert was in May of 2015 where he explained that most sentiment measures were showing investors to be all in. This meant, he believed, that returns for the stock market were likely to be weak with a much higher risk for a correction in the months ahead. To Jason’s credit, that’s exactly what happened. The S&P 500 put in a high that month around 2130 before suffering two steep corrections months later.
Source: Stockcharts.com
Jason is now saying that some of the same patterns of optimism are appearing, which could pose a headwind for the stock market in the months ahead. Here’s a clip from last week’s interview where he explained what’s giving him caution:
Audio Length – 00:00:42
Sentiment Signaling Short-term Risk
Sentiment is useful for trying to gauge risk versus reward, and in the May 2015 time frame, the risk was quite high relative the potential upside. Now, we’re in a somewhat similar situation, he said.
This starts to become apparent from a sentiment perspective if we look at Rydex mutual fund traders, which, as he mentioned in the clip above, are “extremely bullish”.
“Overall, they’ve got about $14 invested in bullish index funds for every $1 they’ve got in inverse funds that would profit on a market decline. Just in the past few days, that moved to an all-time record.”
We would have to go back to March 2000 to see the next highest peak, then around a $13-to-$1 ratio. While the indications from this group’s behavior aren’t perfect, it has worked for 20 years, Goepfert noted.
“Clearly we’re seeing really high optimism among these traders,” he said. “It’s really the optimism behind that—the sentiment behind that—that’s probably transferable to the broader market. For us, that’s a very troubling sign.”
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