Negative Sentiment Could Boost Market

On Dec. 20, I noted in Columnist Conversation that my market perspectives remain a "bear sandwich" of sorts: "short-term bearish, then bullish into mid-2005, and bearish beyond."

I believe that the first part of that bear sandwich is now coming to an end. I sent a note to clients yesterday morning, suggesting that they should start getting long ahead of the State of the Union address. My thinking is that the next leg up is just about at hand, but I included a caveat that this leg is likely to be a dangerous move, and one that might ultimately end badly. Regardless, institutional traders measure performance in months, not years, and they cannot afford to miss a potential two- to six-month rally.

To present a clearer understanding of my thinking, let's look at two factors: market internals and sentiment.

I almost never rely on a single indicator to shift me from bearish to bullish. The market is far too complex a mechanism, driven by too many variables, to rely on a single data point for making decisions. That's why theories like the January effect, the Super Bowl indicator, or years that end in 5 are without meaning to me. I need to see a causal relationship that remains predictive throughout a variety of conditions. None of these single variables has demonstrated an impressive track record to me.

But I do closely watch market internals, and this week I saw some very encouraging signs going forward. As the chart below reveals, the downtrend in the S&P 500 cumulative A/D line has been broken. This is a marked improvement in market internals.

Source: The Maxim Group

If you look at the SPX advance decline chart, you can see how it topped and reversed back in late December. Not surprisingly, the overall market began a downtrend then. As of this week, the A/D downtrend has been broken, and right at the spot where it met the longer uptrend from last summer (What a coincidence!).

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Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries, and is a member of the board of directors of Burst.com, a streaming media software company. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback and invites you to send it to [e-mail].