Our Cyclical Trend Score (CTS) searches for likely cyclical inflection points in the stock market through the analysis of a large basket of fundamental, technical, internal and sentiment data. As we noted last week, the sentiment component of the CTS has moved into sell territory, indicating that the current rally has become vulnerable to the development of a potentially violent overbought correction. This week, the sentiment score has moved further into sell territory, declining to the lowest level since 2011.
Every time the sentiment score has declined into the red area on the chart above, a violent correction has followed. This type of market behavior is typical during late-stage cyclical bull markets that occur during secular bear markets. Earlier this week, our computer models indicated that stock market investment risk had increased to the highest level during the last 84 years, urging extreme caution from a long-term perspective. However, the sentiment score move into sell territory suggests that short-term risk is also very high. Therefore, traders should remain prepared for the likely development of a meaningful retracement sometime during the next several weeks.