Posted by George Smith, CFA, CAIA, CIPM, Portfolio Strategist
The latest weekly data from the American Association of Individual Investors (AAII) showed a continued increase in the percentage of individual investors who are bullish about short-term market expectations (32.2%), and a continued reduction in the number of bears (36.7%). This puts the spread between the bulls and the bears at -4.5%, still slightly bearish overall but at the lowest level of pessimism since the end of March 2022.
“Bullish investor sentiment seems to be re-appearing in the AAII survey data as the equity markets have rallied from the June lows” said LPL Financial Portfolio Strategist George Smith “This could be most reflective of the strong bounce in some of the more speculative growth names favored by many retail investors.”
As shown in the LPL Chart of the Day, investor sentiment, as measured by the spread between bulls and bears in the AAII data, has been recovering, along with the stock markets, since mid-June. So far in 2022 the spread only veered into bullish territory once (at the end of March) but we suspect if the market manages to hold this current rally we may see a positive number again next Thursday.
We tend to view the AAII as a contrarian indicator with extremes in negative sentiment tending, on average, to be bullish for near-term stock market returns and that extreme optimism tends to be bearish for the near-term outlook for stocks. This indicator can be a bit early; as shown in the table below, 3-month returns after the spread gets very bearish are only just above average but the average stock returns 6 months and 1 year out are better than average. This trend appears to be continuing in 2022 with extreme pessimism, as measured by a bull-bear spread more than two standard deviations below average, occurring early in the bear market, from mid-January onwards. If the S&P 500 doesn’t recover above those January levels (4400s) by the same point in 2023 it will be the first time since mid-2008 that an extreme in AAII data pessimism will have yielded a negative return one year out. For the time being on this signal we are into no-man’s-land, where it no longer provides strong future guidance either way other than to expect average returns, but we will be continuing to monitor for divergences to extreme levels.
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