Friday's consumer sentiment data was credited, rightly or wrongly, with triggering the market's selloff. And that highlights an ongoing debate over just how useful sentiment data is in market timing.

Consider Wednesday's Investors Intelligence survey from Chartcraft.com, which saw bearishness fall to its lowest level since April 1987. Despite the apparently contrarian implications of that survey, major averages rallied sharply Wednesday and were able to overcome intraday weakness on Thursday.

Along the same line, but more dramatically, major averages have rallied steadily since late April, when the CBOE Market Volatility Index and its Nasdaq counterpart fell to levels many considered evident of widespread euphoria. But anyone betting against stocks based solely on the VIX, for example, has been on the wrong side of the market for some time now.

These "real world" examples suggest that, on a standalone basis, sentiment indicators don't tell us much about where the market is headed. Sentiment must be combined with other factors to have any functionality as market-timing tools, and even then some academic work suggests they're still not terribly useful to traders.

To begin, let's assume there is some value in gauging sentiment, which is widely viewed as a contrarian indicator. Too much optimism suggests everyone who's going to buy stocks has already done so, and thus the market is due for a fall. The opposite holds true for bearish sentiment. In the current environment, then, perhaps all the talk about how optimistic "everyone" is indicates that maybe sentiment isn't so upbeat after all. In other words, if everyone is so worried about sentiment, how optimistic can they be?

On a less philosophical basis, Nasdaq 100 Trust ( QQQ) puts have consistently been the most active option in the past two weeks. Such "protective buying underneath the rally points to the distrust for the sustainability of this rally," as RealMoney.com contributor Steve Smith observed.

Moreover, recent declines in the VIX and VXN may be more a function of the sharp increase in convertible bond offerings vs. any signal of investor complacency.

"Issuance of convertibles increases the supply of call options and therefore the supply of volatility, in turn it artificially suppresses the price of volatility," according to Paddy Jilek, chief investment officer at Credit Suisse First Boston. "In that sense, the low VIX is currently giving a misleading impression." (The VXN has risen over 17% since late May but the VIX is relatively flat since bottoming at 21.38 on May 23.)

On a simpler level, maybe there's less to all this sentiment stuff than meets the eye.

Sentiment "gives the best signals when it contradicts the market, not when it goes with it," observed Ike Iossif, president of Aegean Capital in Chino Hills, Calif. "If the market begins to decline and bullishness increases -- as it did in February 2002 -- then you've got a problem."

Technical indicators are pointing in one direction: Currently, major averages are well above their 200-day moving averages, and the moving averages themselves are turning up, Iossif noted. In addition, the S&P is making higher lows and higher highs, and there are triple-digit 52-week highs every day -- 301 on the Big Board and 171 over the counter on Friday. "All these are bullish developments so you've got to expect people to turn bullish," he said. "I would not short the market just because there are too many bulls around. I would short if the market declined, and bullish sentiment got even more bullish."

Iossif is actually pursuing a market-neutral tack these days because although technical indicators are "all bullish, my fundamental indicators are negative," he said.

Finally, there is the argument that maybe there's really nothing to this sentiment stuff after all. That, at least, was the finding of a study by Ken Fisher, CEO of Fisher Investments, and Meir Statman, the Glenn Klimek Professor of Finance at Santa Clara University.

"We found the relationship between the sentiment of newsletter writers" -- as measured by the Investors Intelligence survey -- "and future S&P 500 returns to be negative but not statistically significant," concluded the study, which was published in the March/April 2000 issue of Financial Analysts Journal.

In other words, newsletter writers may be contrarian indicators, but not enough to bet on.

Given that the study was published three years ago, why do market participants and journalists still pay such close attention to the Investors Intelligence data? "Myths die hard. People are slow to learn," Fisher said via email last week.

I know what many of you are thinking: Fisher is quite bullish these days, so it behooves him to discount sentiment, which on the surface says the rally is getting long in the tooth.
Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to Aaron L. Task.