Optimism is a wonderful character trait. It is far more pleasant to spend time with optimistic people. It works in your favor in just about every facet of life. But it does not work in the investing arena. I believe it is Warren Buffet who said "Optimism is the enemy of rational thinking". Please excuse me if I am paraphrasing or even have the wrong individual but I mention this because I have had a strong belief that markets have been driven by hope and optimism over the last 6 months at least. The media feeds into this optimism with "The Headline". It may regard rising GDP, consumer sales, strong earnings growth or what have you. But as always, the "rest of the story" lay in the details and what makes up the headline number. And those numbers have consistently pointed to as weak a recovery as we have ever had. Usually, the more severe the correction, the stronger the recovery. But that is not true today. It would take far too much space to go into detail, but generally I believe the following holds true. The recovery beginning in March 09 was a relief recovery when the all clear signal made us secure that the world as we know it was going to survive. The recovery was logical and was coming from a point of undervaluation in many top stock names and safe bonds. At some point, the recovery changed colors and it could be clearly seen that we were putting risk back on the table in a big way. I continued to notice that Small Caps were easily outperforming quality and strong balance sheet companies, though a number of top equity and asset managers a la Jeremy Grantham were endorsing quality as the class to be overweighting. This seemed to continue ad-nauseum even though anyone who did the simplest reading beneath the surface could see that there was truly no organic growth. The "good numbers" were coming from government spending and fiscal policy and hand outs to help the consumer, inventory restocking, temporary programs such as the first time home tax credit, and abnormally high and probably unsustainable margins at the company level as skeleton crews and the shut down of capacity made the company earnings report shine.

Everything pointed to a deflationary environment which was not improving. Credit is contracting. Decent jobs reports are masking the fact that wages are either falling or stagnant. The dollar is rising. Commodities (economically important ones) are falling off a cliff. Housing is hinting at another step down. The largest retailers are cutting prices. The European bailout package is putting severe restrictions on Greece to reduce deficits and debt, ensuring GDP will be cut by several points. Maybe Greece's problems will not impact us greatly, but can Spain be far behind. It all leads me to believe we will see negative GDP once again before a final outcome.

I believe that the most important thing of all to understand about the current period is the fact that there is no historical precedent for it, We are in totally uncharted waters. The 1930s and Japan can only provide us with the fact that inaction was a disaster. But it does not provide any evidence that massive government spending, zero interest rates and quantitative easing, will succeed. And with no more tools in the shed, what happens? And the 1970s are not in play at all despite the fact that everyone from the New York Times, to numerous analysts have already decided that we need to be prepared for the coming inflation and rising rate environment. Maybe so, but that will only occur if governments do not make good on their fiscal austerity and tightening plans.

In this environment, markets roared ahead until recently. I have watched, diligently, the market action. We did get what you refer to as warning shots in time to make tactical changes. I believe, in the unknown, wealth preservation is the only thing that matters for the individual. But I have noticed something else and have not shied away from trying to take advantage of it. It seems to me that the general confusion and difference of opinion has made the buy low, sell high trading method work beautifully. I believe we are in a range bound market that is part of a secular bear market and many trading vehicles are giving good signals as to when to step in against the short term trend. I think this is holding true in commodities, the more volatile equity markets, sovereign bond markets, and currency markets, whether FX or futures. Inter-market relationships are providing tells for risk on and risk off and if one stays careful, it is a good environment to trade. In other words, because there is still general optimism in sentiment and we were approaching record bull-bear % differences (pro-bull) just recently, I would expect a step process heading towards much lower levels. And at those levels, it might be time to re-enter positions in quality global companies.

David Fuller's view Many thanks for your detailed summary. You make a number of good points.

Regarding sentiment in markets, I think any investor can do quite well if they are able to objectively identify extremes of bullish or bearish sentiment, especially when confirmed by persistent and perhaps climactic price action, and recognise that those extremes are contrary indicators.