Welcome back, fellow traders! Did you successfully cope with (or are you still successfully coping with) the cold snap that swept across most of the northeastern quarter of the country last night? Brrrrr. Stay warm, and to the extent it helps, the first day of spring is only eleven weeks away! Just imagine yourself in the nearby picture of the summertime beach scene. Doesn't help? Oh, well. I had to try. Now, about this market... I've got a couple of quick thoughts/observations about stocks today, but mostly I want to take a closer look at just how crazy - and dangerous - the bullishness from amateur investors has gotten. First things first. You know, we're now three trading days into the new year, and we've yet to see any bullishness. In fact, we've seen some pretty decided bearishness for two of the first three days of 2014. If you're a believer of the "first five days" theory we described a couple of newsletters ago, then we don't have a lot of time to squeeze out something positive for the market (year-to-date) by Wednesday's close. If we don't make net progress for the year by Wednesday, it's an omen that the whole year should be bearish. Now, I don't necessarily believe a bearish first week inherently means stocks aren't worth owning for the following 51 weeks. But, I do believe investors have a strong tendency to create self-fulfilling prophecies, and if the market thinks stocks are "supposed to" be weak in 2014, investors will act and trade accordingly. Let's cross that bridge on Wednesday though. In fact, even if things remain bearish through Wednesday, it's not like the market's past the point of no return. The S&P 500 still has a lot of technical support waiting for it around 1812. The NASDAQ Composite is still holding above a key line (the 20-day moving average line) in the sand around 4091 as well. Until those levels are broken, any kind of near-term bearish outlook is nothing more than a guess. Take a look at the S&P 500 below to see what I mean. Now, that's a short-term look, and specifically not a long-term look. There's something else going on with stocks right now that's longer-term in nature, and it's pretty darn scary. I'm sure I've mentioned this to you before, but for anybody's who's forgotten or for anybody's who new to the SmallCap Network newsletter, we're contrarians. By that, I just mean whatever the prevailing opinion of stocks is at any given time, we're expecting the market's tide to turn in the other direction. In other words, when the majority of people are bullish, we're bearish, and when people are mostly bearish, we're bullish. It sounds crazy, but it works. If you want some proof that it works, all you have to do is look at the chart of the S&P 500 and the VIX. The VIX is (sort of) an indication of short-term trader sentiment. When the VIX gets too high - or too bearish - it usually means the market's getting near a trade-worthy bottom. We saw a couple of high-VIX-market-bottoms in late August and early September. We also saw the market peak when the VIX was at an extreme low (when bullishness was rampant) in mid-September. All those reversals are marked with arrows on the chart. It's not an absolutely perfect tool, but it's a good one, and one well worth following. So what happens when you take a step back and look at longer-term sentiment data? It still works - too much bullishness and optimism is usually seen right before market tops, and extreme bearishness is evident right when stocks are at a major low. Yeah, well, optimism and bullishness are as high now as they've been in years... literally. It may be time to get worried. As for how we can measure investor sentiment, there are a bunch of ways to do it. All of them are at multi-year-high levels of optimism. One of them is the AAII (American Association of Individual Investors) sentiment survey. As of the week ending on January 2nd, 43.1% of the AAII's voters say they're bullish, and 29.3% are bearish; 27.6% of them are neutral. It doesn't sound like wild bullishness, but that's almost the highest level of bullishness we've seen in nearly three years. The peak was hit a week earlier, when bullishness was at 55.0% and bearishness was at 18.5%. It's not just the AAII sentiment survey saying bullishness is rampant here. The Investor's Intelligence Index now stands at 81%. That's the highest level we've seen since January of 1987. The Investor's Intelligence Index is a combination/comparison of that survey's bullish and bearish percentage scores. The bullish percentage is at 59%, which is the highest level since September of 2008. The bearish percentage now stands at 14%, which is the lowest reading since early 1987. The Hulbert Financial Newsletter Sentiment Index (for all stocks) now stands at 82%... the highest reading in at least 15 years. [My data doesn't go back any further than that.] Now, some of you may be wondering what's wrong with lots of optimism. Isn't bullishness what allows the market to go higher? The answer is yes, but too much of anything is still too much, and there's something of a history of the market pulling back when we get to the point where the market's as bloated and confident as it can possibly get. See, most people don't get bullish until they're in the market. If optimism has reached its maximum capacity, then there may be no buyers left. I want to show you some real life examples of how excessive bullishness tends to lead to problems for the market, but before I do, I'll give credit where it's due - Mark Hulbert keeps better tabs on the sentiment stuff than anyone else out there. He's the guy who's making it easy for me to make my point today. On that note..... On April 10th, of 2010, Hulbert wrote "Sentiment nears dangerous levels." Take a look at what happened over the following few weeks. On February 11th, 2011, Hulbert penned "Bullish sentiment is high - maybe too high." The market soon made more than a minor pullback. And finally, Mark Hulbert penned "Whiplash" was written in early November of 2010, pointing out how optimism had reached unusually high levels. Sure enough... Now, just for the record, there have been plenty of times optimism has been strangely high and the market just keep right on rallying anyway. Some of these pullbacks didn't last that long either. The premise isn't perfect, and it's certainly not laser-precise in terms of timing the exact top and bottom in question. It's clear that there's a potential pullback on the radar when sentiment reaches this kind of level, though, and in my experience, being a contrarian has paid off more than it hasn't. As for the shape of things to come right now, I'll just leave you with this: Most traders think the market's more buy-worthy now than it's been in years, if not decades. That's a ton of confidence. While I don't think stocks are headed off of a cliff and doomed forever, the economy isn't firing on all cylinders, and the S&P 500's trailing P/E is just a hair under 19.0 now. That's about as high as the market can justify in any situation, let alone in a lethargic economy. Even the forward-looking P/E ratio of 16.6 is pushing the market's boundaries. To me, this degree of optimism is unhealthy, and a recipe for a pullback when valuations are at their upper limit. While I can't say it's going to happen in January (and despite the fact that I made the point of not assuming a pullback is inevitable after XYZ time), I have to think we're closer to a correction than we've been in months. And I don't mean just a mere trip back to the S&P 500's 1800-ish level. That would only be about a 3% stumble. I'm talking more about an 8% to 10% correction, which is in line with the norm. I'll just add this detail to our chat ... I'll be a strong buyer when we get to the bottom of that pullback. It'll be marked by - you got it - an obnoxiously high VIX. By the way, Fred's (FRED) hit our mental stop-loss level today, which means we have to make a decision. I'm inclined to hold it for at least another session, as I've got a feeling the stock's selling pressure on Monday was more marketrelated than company-related. I think we can reclaim some of that lost ground on Tuesday, especially now that we saw the 20-day moving average line start to act as support. If not, we'll pull the plug tomorrow, for Wednesday. Either way, we may have a new pick for you in tomorrow's newsletter. Stay tuned, and stay warm.