Negative Sentiment Could Boost Market

This is the first sign of improving internals since the market topped out (short-term) in late December 2004. Incidentally, I never considered the 2005 selloff as the end of the rally because of the A/D line. Before major tops, a divergence between price and the A/D line develops. That hasn't occurred here. To quote Kevin Lane, Technimental's chief strategist, "The A/D uptrend remains in effect, and you must respect the trend." I agree.

Secondly, I note the confirming shift in prevailing sentiment from excessively exuberant in December -- when bulls were close to 70% of the AAII surveyed investors -- to more bearish as of late. The AAII reported this week that member investors who described themselves as bullish dropped to 26.43%. This is a significant shift, from greed to fear.

Recall the last time caution was thrown to the wind was in late December. The prevailing sentiment was extensive bullishness and the market rewarded that by selling off for five weeks. Now, in the face of good (albeit decelerating) earnings and a positive initial outcome in Iraq, it seems that fear and caution are ruling the markets.

Cool Heads Prevail After Iraqi Vote

The generalized caution kept the party sober after Sunday's elections in Iraq. And that's a good thing. Why? The success of the elections in Iraq sets the stage for the next leg upwards in the market, as it reveals a cautious sentiment. In more bullish moments, the successful elections would have jumpstarted a 200-point rally. Yet the modest, even sober reaction shows that caution is still the watchword and suggests that people are sitting on their capital.

The reality is, the Iraq elections have a bare minimal effect on market fundamentals. In fact, if anything, the numbers are decaying. The elections in Iraq do not lower P/Es, change our balance of trade problems, raise GDP, lower federal deficits, increase hiring, stop interest rates from going higher or eliminate al Qaeda.

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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].