As of late we have heard a lot about how sentiment was too bearish and that this justified the market rally.

While we no doubt got a rally, we have to question the idea that sentiment is overdone to the downside. In the world of sentiment indicators there are more then a few ways to look at things. You can look at polls like Investors Intelligence or the AAII numbers, you can look at anecdotal indicators like covers at the magazine rack or listening to your shoeshine boy, and finally you can look at market derived indicators.

Looking at poll data alone would have you thinking that either the world is coming to an end or that we are due for a large counter sentiment trade. The first chart here is of the Investors Intelligence Bulls to Bears ratio popularized by Marty Zweig. As you can see in the chart it is hitting lows not seen since 2008.

Investors Intelligence Bulls Bears Ratio

If you want an equally extreme way to look at it below is a chart of the Investors Intelligence percent bears. As you can see we are spiking to new highs not seen since the dark days of 2008.

Investors Intelligence Percent Bears

Looking at just these two charts makes the trend followers short and happy, and the contrarian leveraged long. Of course, we have a lot more tools at our disposal then just the Investors Intelligence poll data. We like to check the poll based data against the market based data to see if it is inline with what investors are actually doing. Usually it is, but sometimes it gets out of line. As you can probably guess now is one of those times.

In the chart below we have taken the VIX and overlaid the percent bears. As you can see both indicators usually move roughly to the same beat but lately the poll data has been getting more and more negative while the market derived data, data that actually shows where people are putting their money, has been getting more positive.

VIX and Investors Intelligence % Bears

Because of this disconnect we think that sentiment is not overdone to the bear side and that there is still some room to the downside. In fact one of our short term sentiment indicators is showing exactly that as the 5-day equity only put call ratio hit .55 yesterday. This level is significant as it has done an excellent job of showing when things are in fact too optimistic and has a good record calling tops in the equity market. So while we aren’t calling for some Dow 1,000 crash, our analysis which includes sentiment data, does show room for more downside.

5-Day Equity Only Put Call Ratio

Disclaimer: In our model portfolio we are long some SPY puts