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Forget Twitter -- Cautionary Signals Continue to Build

"Distrust and caution are the parents of security." - Benjamin Franklin

NEW YORK (TheStreet) -- The highly anticipated Twitter (TWTR) initial public offering is finally here and is not disappointing thus far. Shares closed at$44.90, up a whopping 73%, compared with its IPO price of $26. With the Twitter IPO and new all-time highs in the broad indices, euphoria over U.S. equities continues to hit multi-year extremes.

The spread between bulls (55.2%) and bears (15.6%) in the Investors Intelligence Poll moved up to 39.6% this week, the second-highest level since the low in March 2009. The last time the spread was this high was back in April of 2011, which coincided with a top in the S&P 500 and subsequent decline of over 20%.

Before that, you have to go back to the October 2007 peak to find sentiment at a similar extreme.

With the Twitter IPO, the current backdrop brings to mind the excitement leading up to the Facebook (FB) IPO in May 2012, which coincided with a short-term S&P 500 peak and decline of just over 10%. Most investors today cannot fathom such a scenario, as the belief in the Federal Reserve's ability to prevent market declines has never been stronger.

However, that is precisely why U.S. equities are vulnerable here, if not to a correction than at least to a more rangebound market than what we have been experiencing for the first 10 months of this year.

With the broad indices down over 1% Thursday, investors may finally be waking up to the many cautionary signals that I have been writing about over the past two weeks:

  1. The Global X Social Media ETF (SOCL), Tesla (TSLA), Netflix (NFLX) and other "story" stocks continue to trade weak. When these momentum stocks are underperforming, it is typically a sign of risk-off behavior.
  2. The Russell 2000, as seen in the Russell 2000 ETF (IWM), peaked on a relative basis over a month ago and continues to underperform. This is a negative reflection of overall market breadth, where the average stock has not been able to keep pace with the broad indices.
  3. Defensive sectors viewed through the Consumer Staples ETF (XLP) continue to outperform, a sign of risk-off behavior.
  4. The PowerShares DB Commodity Index Tracking Fund (DBC) continues to decline, trading at its lowest levels since June; this is further evidence of deflationary behavior.
  5. The Guggenheim CurrencyShares Japanese Yen ETF (FXY) has been unable to hit new lows and is trading sharply higher, a sign of risk-off behavior.
  6. European financials continue to trade weak, calling into question the European recovery thesis.
  7. Investor sentiment from multiple indicators is at overbullish extremes. From such extreme levels in the past, we have typically seen below average performance in the S&P 500 going forward.

Overall, until we see some improvement in these indicators, continued caution is warranted. While favorable seasonality until year's end may lower the probability of a large correction here, that doesn't mean the probability is zero and we should ignore these red flags.

Our ATAC models used for managing our mutual fund and separate accounts continue to reflect a more cautious outlook, favoring bonds over stocks in the near term.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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