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With Investors So Bullish, Pullback Must Be Coming

With many investors convinced stocks are going higher, economic data improving and Greece's debt crisis moving toward some kind of conclusion, now could be the perfect time for a market pullback.

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Yes, it sounds counterintuitive to expect the market to go down when so many things seem to be pointing up. But this is the stuff corrections are historically made of — buoyant sentiment that precedes a retreat.

"While some market observers view high investor bullishness as an indicator that stocks will continue to advance, we believe lopsided sentiment is the Achilles’ heel for markets," Daniel Aaronson and Lee Markowitz, of Continental Capital Advisors in New York, wrote in a recent analysis.

"The four-month rally that started at the October 2011 interim low has led to a surge in investor bullishness and positioning," they continued, "which when combined with insurmountable sovereign debt problems, sets the backdrop for a major decline in equities."

Indeed, while the market's rally since October has been impressive — taking it to gains normally associated with bull markets — most of the underlying problems that made stock market investing such a dismal affair in 2011 remain.

For one, there are fundamental issues.

Investors again this week got caught being overly optimistic about a resolution to Greece's debt problems. An apparent austerity agreement that would allow the troubled nation to get the next installment in its financial aid package appears to be falling apart.

And while the recent gains in employment, auto sales and other economic measures show improvement, worry remains that the gains may not last. Those fears have been fueled by the Federal Reserve , which has warned that the economy remains on shaky ground.

"The US economic numbers are a little better, the disaster in Greece appears to be averted. But where is the growth going to come from?" says Uri Landesman, president of Platinum Partners hedge fund in New York. "The risk is to the downside. Bad economic data, bad earnings news, bad news from Europe could really take the market lower from these prices. Just to sustain the current levels you'd need a surfeit of good news."

Landesman sees the Standard & Poor's 500 retreating perhaps 8 percent from here — underscoring the important point that among those expecting that the stock marketis heading lower, few are predicting a catastrophe. Eventually, he thinks the index could touch 1100 before rebounding and actually finishing the year stronger.

A healthy pullback of 3 to 5 percent looms should the S&P reach the 1360 to 1380 area, says Sam Stovall, chief equity strategist at S&P.

"The market rarely does what the majority expects," Stovall says. "Either it will evade a meaningful early setback attempt, or won’t be given a chance to recover from it. We believe the former to be the most likely outcome."

But the other part of the current market's troubles lies in technicals.

Aaronson and Markowitz point out that market sentimentas measured through the American Association of Individual Investors survey is at a point that has coincided with recent market tops. The AAII's most recent poll puts bulls ahead of bears 51.6 percent to 28.2 percent. The AAII's Charles Rotblut calls the level "an unusually high level, but not an extraordinarily high level," suggesting the rally could still have some breath.

But there are other even more troubling technical indicators.

Abigail Doolittle at Peak Theories Research said the S&P 500 has failed in its effort to reach what technicians refer to as a "double top" — an M-shaped move in which the market hits a top twice then falls — which she sees as indicative of more trouble to come.

The S&P as well as the global economy actually could rise some from here before seeing a major decline, Doolittle says.

"Should the overall bearish picture presented by these long-term equity index charts come true and one that should begin to show itself in 2012 and even in the first half of this year, it suggests that the global economy is headed into a twin of the Great Recession if not an outright depression," she wrote in an analysis.

To be sure, the technical charts suggest a scenario not universally shared among the market's bigger names.

Economist and famed doomsayer Nouriel Roubini recently made headlines for making a bullish case for stocks. BlackRock's Larry Fink suggested investors go 100 percent into equities, while Warren Buffett and others warn that the long bond market rally could be nearing an end, making another bullish case for stock ownership.

Yet it's at just such levels, where the big market mavens are wildly enthusiastic about stocks, that bull markets reach their peaks and need a break.

"We're due for a breather," says Phil Silverman, managing partner and portfolio manager at Kingsview Capital in New York. "We're in a sideways secular market that is going to last until later in this decade. But that doesn't mean we're not going to have cyclical bear and bull markets within that."

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