A split in sentiment....danger for Chinese stocks

Something quite unusual has happened. The most recent American Association of Individual Investors survey is showing 28% Bulls and 49% Bears which has solid bullish implications for the market. However Investor's Intelligence sentiment is showing 44% bulls and 27% bears which is almost the exact opposite and hence has bearish implications. So which message should you listen too? The answer could be both. AAII sentiment tends to be much more fickle than II sentiment and tends to be more useful for short term market timing whereas II is more for intermediate term timing. Therefore, the conclusions drawn here are that the market looks bullish in the shorter term (1-2 weeks) bearish in the intermediate term i.e. any gains from here will be limited. …SPX 940 is doable. This fits with a host of other indicators I track.

I believe that the damage done to the market last year and early this year has created a recalability trap in traders which is a fancy way of saying that they are being unduly influenced by their bad experiences in the market. Anytime the market has a dip they think that it's going to be the start of another 20-30% drop. Until enough people drop their guard I doubt the market is going to see such a drop. Traders behaved this way after the rebound from the 911 crash and it took a 3 month rally and 3 months of topping before the final downleg ensued. By then most bears were too crippled to take advantage or they covered shorts far too early after getting repeatidly punished going for the kill in the months prior.

Another warning sign I've noticed pertains to Chinese stocks. On BNN (the Canadian equivalent to CNBC) there's a commercial running for a website that researches Chinese stocks. Last year around this time they had commercials running for Potash companies with the catch phase "feed the world". A major top for potash and commodities stocks followed shortly. I'm not suggesting you bet your house on shorting Chinese stocks just because of this one commercial, however, when you combine this contrarian indicator with the more powerful contrarian indicator of massive inflows into emerging market funds which are at levels that match those seen at the major top in that sector that occurred in 2007 you get a much stonger confirmation that a top is immanent. I also find that the financial media and it's pundits all seem to be saying that if you want exposure to equities go with emerging markets because they offer the most growth potential and they should lead the recovery.

Therefore, as per the contrary indicators I mentioned and the motto of this site, I think the message is clear....emerging markets are dangerous right now at least for the medium term. In fact, they may have already peaked.

Bottom line....look for rising markets in the short term (1-2 week time frame) but I say this tentatively because danger lurks in the intermediate term. We could very well be forming another major top here but that top could be several months in the making and it could be as long as September-October before the top is complete. All in all, it looks as if the summer doldrums have arrived.