Too Much Bullish Stock Market Sentiment?

By: Sy_Harding

By far the majority with skin in the game of investing have little or no interest in the details of how their money is treated when left on its own.

I speak with people all the time who make remarks like, “I threw my 401K statements in a drawer unopened for almost a year. I couldn’t stand the losses. But with all the talk of the stock market being up 50% I figured I’m good again, and opened the last one. I’m still down 30%. Thirty percent of my savings are still gone. The market’s up 50% and I’m still down 30%. I don’t get it.”

Well yeah. The stock market has had its biggest and fastest rally since the 1930’s off its March low, with the S&P 500 up 52% in just 5 months. But the problem is that in the bear market it lost 57% of its value. If you start out with $100,000 and lose 57% of it you have $43,000 left. You’d have to more than double it, in fact make a 132% gain, to get back to $100,000. So the S&P 500 is still down 35% from its level at the top of the bull market in 2007. (It would need to gain another 54% from here to be back to its 2007 top). And in fact, in spite of its 52% rally off the March low it is only up 12% for the year so far, the 25% plunge in January and February was so severe.

So I ask them why they didn’t do something to stem the losses instead of ignoring them, and they say they aren’t knowledgeable enough to know what to do, don’t have time to learn, and their advisor or their employer or their friends told them to just stay the course, the market always comes back.

It seems like slogans are often substituted for knowledge or planning. When the market is going down the popular slogans are “The market always comes back.” “The market can’t be timed.” “Stay the course.”
When the market has been going up long enough to look potentially overbought, the popular slogans become “Buy the dips.” “Bull markets always climb a wall of worry.”

As I pointed out in my 1999 book Riding the Bear – How to Prosper in the Coming Bear Market, the result is that many investors stay invested all the way down in bear markets and then bail out in disgust when the losses become too painful. Then they don’t become interested again until the next big rally has been underway for some time, may be near its top, and then become increasingly confident, buying ever more aggressively. The pattern has remained the same for more than a hundred years.

I bring that up because a number of previously bullish professionals and Wall Street insiders are now calling for a market correction.
I’m wondering if that happens if investors will be prepared, or will the age-old pattern repeat?

I wonder because another Wall Street slogan has become popular, “The market will do whatever it must to fool the majority.” And when I mentioned on my daily blog last Saturday that a number of previously bullish Wall Street insiders and professionals are now calling for a market correction, I received quite a few e-mails. They pointed out that “Yes, a lot of analysts are now calling for a correction, but that is a ‘contrary’ indicator. The market does whatever it must to fool the majority. So many calling for a correction is a sure sign the market is going higher. Buy, buy, buy.”

Well, yes, it’s true that investor sentiment is a ‘contrary’ indicator, meaning the market will usually move contrary to expectations when sentiment reaches an extreme of either bullishness or bearishness. But the ‘contrary’ indicator is based on the sentiment of public investors, not Wall Street insiders and professionals.

And therein lies a current potential problem for the market.

While an increasing number of previously bullish professionals are calling for a correction, the latest poll of its members by the American Association of Individual Investors shows 51% are now bullish. That’s a high number historically for this poll. In our work, based on its history, we consider the AAII poll to have reached the danger zone for the market when bullishness rises to between 50 and 55%. By the way, the current 51% bullish reading is a big reversal from the 54.6% that were bearish in the July 9 poll, just one-day before the market reversed after a four week decline and exploded into the additional rally of the last 5 weeks.

Also this week, Investors Intelligence reported its sentiment index has reached 49.4%, which is its highest level since December, 2007, while bearishness has fallen to only 21.3%, its lowest level since October, 2007. Both readings were near the last bull market’s top in October, 2007.

Several other sentiment indicators we follow, including the VIX Index (aka the Fear Index) are also flashing warning signs that investors have become too confident and bullish, just as Wall Street insiders and professionals are increasingly warning the market has come too far too fast and is due for a correction.

Something to think about.

Sy Harding publishes the financial website www.StreetSmartReport.com and a free daily market blog at www.SyHardingblog.com.

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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