US Markets

The stock market just stepped into the 'danger' zone

Market fundamentals vs. valuations
Market fundamentals vs. valuations

Professional investors are getting really confident that the stock market will keep moving higher — maybe a little too confident.

A popular gauge of investor sentiment, in fact, is flashing a signal that the latest runup in equity prices to fresh record highs is getting overheated. The Investors Intelligence survey, which measures the attitudes of more than 100 investor newsletter authors, is showing bullishness at 56.2 percent of respondents, which is indicative of an unusually high level of optimism.

That reading "is considered the danger level," said John Gray, co-editor of the Investors Intelligence newsletter, which interprets high levels of sentiment in either direction as indicators that the market is poised to head the other way in the near term.

Gray notes that when the bullish level exceeds 55 percent, it has been consistent with a market pullback. It happened in February 2015 and then in April of the same year, when the market was on a ride that eventually would take the down about 15 percent in 12 months' time.

Gray said judging by current conditions, the bulls could have room to run.

"Early July saw the bulls exceed 50 percent and we said it might take the Nasdaq comp joining other ongoing index highs to achieve the capitulation to boost the reading to into the top region," he said. "The bulls could still advance further to equal those 2015 peak levels."

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The bear level is all the way down to 20 percent, which is near a multiyear low. That bull-bear spread of 36.2 percentage points is nearly 3 percentage points higher just in the past week and is the widest since early 2015, just before the market slide. Gray said a spread of more than 30 percentage points is indicative of "higher risk" ahead, while a 40 percentage point difference points to "danger."

"In general the bears note weak world economies and expect U.S. stocks to ultimately suffer as a result," Gray said. "They also continue to note the more than seven-year bull run is unusually long."

Bearishness also has come from some top-name investors like Carl Icahn, George Soros and David Tepper, each of whom has taken either a position against the market or trimmed longs.

However, the age of the second-longest bull market run in history has not been a deterrent. The S&P 500 was up 6.3 percent in 2016 heading into Wednesday trading and has gained 227 percent since the Great Recession bottom in March 2009.

The jump in sentiment comes amid conflicting signs.

All three major averages made all-time highs together on Aug. 11, which historically has been a negative sign going forward over the next three-, six- and 12-month periods, according to S&P Global Market Intelligence. Conversely, the next day 80 percent of all sub-industries within the broader S&P 1500, which includes small- and mid-caps as well, broke above their 50-day moving averages. That actually is a positive sign, with the index usually trading higher in the weeks ahead.

Retail investors have been considerably less optimistic than the pros.

The most recent American Association of Individual Investors survey found the bulls at just 31.3 percent, while the bears were at 26.8 percent. Neutrality is carrying the day among the mom-and-pop crowd, with 42 percent saying they expect stock prices to be unchanged over the next six months.

That is reflected in recent fund flows, as mutual fund investors — predominantly retail — pulled nearly $33 billion out of U.S. equity funds in July. Exchange-traded funds, considered to be popular with professional traders, saw inflows of $33.8 billion.