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Market Slaughter Ahead? Herd Indicator Hits 3-Yr. High

Jesse Livermore, legendary trader of the early Twentieth century, had a rule: The stock market is designed to fool most of the people, most of the time. We may be in fool territory.

According to the most widely followed sentiment measure on Wall Street, the number of stock market bulls out there is eerily approaching the highest level since October 2007, the month the stock market hit an all-time high and the worst financial credit crisis since The Great Depression ensued.

The number of bulls rose to 58.8 percent this week, the highest since the 62 percent reading three years ago, according to the long running survey of financial newsletter writers conducted by research firm Investors Intelligence.

The velocity of the conversion from bull to bear is impressive, notes Investor Intelligence, as bulls numbered just 29 percent at the end of August.

“I know of not one bear for 2011,” said Peter Boockvar, chief equity strategist for Miller Tabak. “With the European problems still very much alive, a mini earthquake in the U.S. bond market over the past few weeks, and the likelihood of higher interest rates in Asia and Latin America too, the bulls better be a bit more careful here.”

Those that have turned bullish since August have been rewarded. The S&P 500 is up 23 percent from its 2010 low posted in July as a second round of quantitative easing by the Federal Reserve, improving employment figures, and a tax compromise in Washington fueled further gains.

But now, with so many bulls out there, which bears are left to convert into buyers and take the market even higher, contrarian investors said.

The "USA Today" ran an interview this week with five Wall Street strategists, including Blackrock’s Bob Doll, Goldman Sach’s Abby Joseph Cohen and Bank of America Merrill Lynch’s David Bianco. The headline screamed — Experts Agree: Get Over Your Fear and Get Back Into Stocks.

“I have to admit that as a contrarian, I love articles like this,” wrote David Rosenberg, chief economist & strategist for Canada’s Gluskin Sheff, in a note this week. “The article concludes that ‘each panelist predicted double-digit gains in 2011.’ Now that is what I would refer to as groupthink!”

Rosenberg made a name for himself for his bearishness ahead of the credit crisis despite the fact that he was employed by a firm at the very heart of the problem, Merrill Lynch. This year at Gluskin Sheff, he’s come under fire for remaining bearish during this second half rally in stocks, saying that we’ve yet to pay the price for the housing market collapse and the subsequent bailouts.

That brings us to the one problem with going against the herd to soon. The herd can be right for a long time, traders said.

“This is where it gets slightly complicated because I always wanted to trade along the line of least resistance, so I was generally moving along with the crowd, the herd, most of the time,” said Livermore, according to a 2001 biography entitled, ‘Jesse Livermore, World’s Greatest Stock Trader’. “It was when the change in trend started to appear, the change in market direction, that was the most difficult change to catch and act upon. So I was always ready to separate myself from the popular thinking, the group thinking.”

For the majority of bulls out there, should you?

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Trader disclosure: On Dec. 22, 2010, following stocks and commodities mentioned or intended to be mentioned on CNBC’s "Fast Money" were owned by the "Fast Money" traders; Karen Finerman owns (AAPL), (GOOG), (JPM) and (MSFT). Stephen Weiss owns (DVN), (FAS), (QCOM), (TBT), (VZ), (AKS), (SWC), (COP), (HK) and (NFLX) puts. Tim Seymour owns (AAPL), (BAC) and (F).

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BRIAN KELLY
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