Bears are scarce in the stock market, and that makes some bulls nervous

This article was originally on a blog post platform and may be missing photos, graphics or links. See About archive blog posts.

Among Wall Street pros, nearly everybody has something nice to say about stocks these days. Maybe they should keep it to themselves.

With major U.S. equity indexes up by double-digit percentages this year and optimism rising for the economy in 2011, measures of professional investors’ sentiment are showing high levels of confidence about more market gains in the new year.

But as the number of bulls increases it raises the risk that the market party is getting closer to peaking, because there may be relatively few people left to be pulled in.

One closely watched market sentiment gauge is the Investors Intelligence weekly survey of more than 100 independent investment newsletter writers. The survey asks the writers for their near-term outlook for stock prices. They can pick either ‘bullish,’ ‘bearish’ or ‘correction’ -- the latter indicating the expectation of a short-term market pullback of about 10% in key indexes.

Last week’s survey showed 58.8% of the writers were outright bullish, up from 56.8% the previous week and the highest since the peak reading of 62% in October 2007 -- which was exactly when the Standard & Poor’s 500 index hit its all-time high before plunging in 2008.

The bears totaled 20.6% in the latest survey and the correction camp also totaled 20.6%.

The Investors Intelligence survey, which dates back to 1963, historically has been an excellent contrarian indicator: Extreme readings of bullishness often herald a market slump; on the flip side, a heavy shift to the bear camp often signals that the market is poised to rebound.

Indeed, the bears had totaled 37.7% as of Aug. 31, a level last seen in early-spring of 2009. Both of those points turned out to be great times to be buying stocks.

But even with the bulls in a solid majority now, a deep market sell-off may not yet be imminent. High levels of investor optimism can be sustained for long periods before a rising market finally reaches its zenith. After all, that’s what makes a bull market: Not only are more investors jumping aboard, but many of those already there are reluctant to sell.

When the Investors Intelligence bullish reading hit 56.8% in the survey dated Dec. 14, market research firm Bespoke Investment Group looked back over the last decade to see how many times that level had been reached and how the market subsequently fared.

Bespoke found multiple instances from 2003 to 2007 when the bulls equaled or exceeded 56.8% in the survey. Yet the market kept plowing ahead, with only minor setbacks along the way, until its final peak in October 2007.

Still, if the bulls in the survey soon reach the 62% level seen at the 2007 market top, some investors who’ve been riding the latest surge in share prices may decide that’s as good an excuse as any to take some profits. History doesn’t necessarily repeat, but it often rhymes.

-- Tom Petruno