After some impressive strength earlier this week that returned the major averages to their late May highs, the rebound rally has run out of steam. Investors clearly have a lot on their minds. On the downside, the Federal Reserve and the European Central Bank seem less than eager to deploy fresh monetary policy stimulus. On the upside, Europe appears to be cobbling together a direct bank aid package for Spain, while China's central bank just cut interest rates for the first time since 2008.

I think it's just a temporary pause in what will prove to be a short-term rebound rally. Based on hedge fund positioning and other measures of market sentiment, many investors are very worried and positioned extremely defensively. I think that sets the stage for some upside surprise before the long-term downtrend reasserts itself.

There's plenty of evidence of overly dour sentiment.

The eight-week average of the AAII bull-bear ratio has dropped to its lowest level since April 2009 just as the 2007 bear market was ending. There have been more bears than bulls for eight of the past nine weeks -- the 13th such streak in the survey's history dating to 1987.

This is a huge shift in sentiment. Earlier this year, sentiment had reached an optimistic extreme not seen since late 2010. Before that, investors hadn't been that excited since late 2005.

According to Credit Suisse analysts, the net long positioning of hedge funds serviced by their prime brokerage desk has returned to lows hit last November. Compared to the bull/bear sentiment ratio, hedge fund types are actually more concerned than retail investors are.

Mutual fund outflows have also reached a rare extreme. According to Lipper FMI data, $20 billion has been pulled out of equity mutual funds over the last three months -- a level of selling pressure often associated with at least short-term turnaround points. Recent examples include the late 2011 selloff and the early 2009 drop into the bear market low.

Options traders are freaking out too. Thursday, ISE exchange traders bought only 90 equity call options (betting on higher prices) for every 100 put options (betting on a decline). That has happened only six other times over the last five years. Most recently near the April low. Also, during last September's plunge.

And finally, as shown in the chart above, market breadth has been steadily improving as fewer and fewer stocks participate in the sell-offs. This is a sign of active bargain hunting. This behavior is commonly seen near major market lows.

Keep in mind these are all short- and medium-term indicators. The long-term picture, based on the fundamental economic outlook, is still ugly for all the reasons I've enumerated in my recent columns and blog posts. A broken labor market. A looming fiscal cliff. Increasingly ineffective monetary policy stimulus. Ongoing balance sheet deleveraging by households. Unresolved structural problems in the eurozone. A Chinese real estate bubble.

Leading indicators, from factory activity surveys to global earnings estimate revisions, are all rolling over. Until these measures change, don't view the rebound as anything other than a tradable relief rally.

Trading update
I'm continuing to focus the Edge Letter Sample Portfolio on new areas of strength including semiconductor, emerging market, and precious metals positions. Recent additions include the Direxion 3x Semiconductor Bull (SOXL). For the risk averse, there is the unleveraged Market Vectors Semiconductor (SMH).

The gold and silver positions are doing well. The Market Vectors Junior Gold Miners (GDXJ) is up 11.3% since I added it on May 17.

Check out Anthony's investment advisory service The Edge. A two-week free trial has been extended to MSN Money readers. Click here to sign up. Contact Anthony at anthony@edgeletter.c​​om and follow him on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.