An Extreme in Bullish Sentiment is a Warning Signal

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Sentiment appears to be changing from bullish to bearish. The e-Yield Sentiment Indicator (ESI) moved to neutral after one of its components, the BTI, turned down yesterday. Sometimes the BTI will be down for a day or two then it will turn up again, this is what I call a false signal. To avoid false signals I use the 34-day BTI (the second component) as a filter. A more reliable sell signal occurs when the BTI AND the 34-day BTI are down at the same time. At the moment the 34-day BTI is still rising so I am waiting for a turn down in this indicator to confirm the BTI’s signal.

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Nevertheless, we should adopt a neutral position in the stock market until we see the confirmation. If the 34-day BTI turns down we can turn bearish and if the BTI turns up we’ll be bullish again. I also recommend a neutral position because the 34-day BTI has risen above 400 (overbought).


A move above 400 coincides with an extreme in bullish sentiment, this condition occurs at market tops. Each time the indicator moves above 400 the FTSE 100 corrects, not necessarily immediately but within a reasonable period of time. The previous move above 400 was on 22nd May, the exact date when the FTSE 100 recorded its highest level this year at 6875.

This time I believe the correction has already started as the FTSE 100 broke a key support level yesterday. There is still no clear indication about the timing of the Fed tapering but judging by the latest economic data, a mixed bag of numbers should delay tapering until January or February next year. The latest reports published yesterday showed that US consumer confidence unexpectedly fell but US housing starts beat estimates.

The weakness of the FTSE 100 relative to the S&P 500 continues. The S&P 500 is hitting new high but the FTSE 100 is going the other way. This should set alarm bells ringing because this is not what we expect to see in a bull market. In a real bull markets indices go up and down together. When a leading index is not responding to the rally, you should be worried. The leading index here is the FTSE 100. I think US investors should keep an eye on the FTSE 100 chart, very often the UK index is ahead of the US indexes in predicting the next move. The fact that the FTSE 100 is weak is not good news for the S&P, sooner or later the S&P will turn down to catch up with the FTSE’s decline. When this happens obviously the decline in the FTSE 100 will accelerate.

I have taken a number of short positions on stocks and some put options as well as I anticipate a correction in the short term. By the time the correction is over – it could be in a few weeks or in a few months – the extreme in bullish sentiment will turn to extreme in bearish sentiment.  During the correction I expect a re-rating in the price earnings ratio that investors are willing to pay. When bearish sentiment reaches an extreme, stocks will trade on a discounted P/E ratio and that will be the time to buy again.

So far my medium/long term forecast calling for a sideways market is on track. The FTSE 100 is still below this year’s high of 6875, according to my indicators a move down to 6500 is expected before the UK index moves back to its previous high. Thereafter I do not expect any significant upside, the area above 6875 is major resistance.  Chances are the UK index will move sideways for a long time, this suits me as my trading strategy is designed for this kind of environment.

Thierry Laduguie is Market Strategist at www.bettertrader.co.uk

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