The Only Market Sentiment That Matters

My erstwhile fellow bears have done much gnashing of teeth among about the extreme readings in the sentiment indicators lately. While still a bear at heart, I became "respectful" of the market's bullish potential when the Fed announced the precursor to QE2 back in August, and have stayed bullish since then, partly because I recognized that the only sentiment that matters is dealer sentiment. With Ben Bernanke stuffing freshly printed cash in their pockets (actually their trading accounts) virtually every day, the dealers are bound to work the market higher until either the Fed stops force feeding them cash, or until frictional forces overwhelm the Fed's printing. We're edging closer to that, but we're not there yet.

Having observed the markets for the past 44 years, one thing I learned a long time ago is that the parameters and behavior of sentiment indicators shift depending on the market environment. What is extreme in a bear market is not extreme in a bull market and vice versa. In the mid to latter stages of a bull market, sentiment can stay pinned at what appears to be a past extreme for a long time. That's because the Fed is usually adding cash to the system during those periods and the Fed's money printing operations (let's call them what they are) float all boats. That's the real driver. The sentiment indicators are rising or floating on a sea of Fed cash.

That's especially true now with the Fed pumping record amounts of cash into dealer accounts every day. We only need to know that fact to know what the dealers are thinking, and since the dealers own the market, that's all we really need to know. So here's what the dealers have been thinking since last year. Notice what happened to the red line when the Fed started taking inventory off their hands and started pumping cash into their trading accounts back in August (click to enlarge).



That's the only sentiment indicator we need to watch. OK, maybe not the only one, but if it isn't related to Fed cash or dealer trading, then it's likely to be irrelevant and even misleading. Until this indicator and others like it reverse, the market will head higher on the sails rigged by the Fed.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.