From time to time, I mention results in the weekly American Association of Individual Investors (AAII) poll. I have mixed feelings about using surveys like this as a timing indicator, as on one hand it measures the pulse of what participants are thinking and feeling. But, on the other hand, it doesn’t necessarily reflect what they are doing as with other sentiment tools at our disposal, such as option activity, fund flows, short interest figures, or allocation surveys.
Nonetheless, when an extreme reading in a survey emerges, I think it is worthwhile to further investigate, which I did when I saw that only 16% of those surveyed in last week’s AAII poll said they were bullish. It was the lowest reading since September 4, 1992 when only 14% claimed to be bullish during a historically weak month for stocks.
The chart below gives you a little context of the S&P 500 Index (SPX—4,392.59) price action before and after that 1992 reading. At the time, the SPX was trading less than 5% above its 252-day moving average, or one-year moving average, and had achieved an all-time high just one month earlier.
One month following the 14% bullish reading, the SPX pulled back slightly below its 252-day moving average, before recovering and rallying over the course of the next year. Most of that advance occurred during a period of historically strong seasonality (October through April).
Now, with only 16% of those participating in the weekly AAII bullish, the SPX is trading around its 252-day moving average and is four months removed from its last all-time high. Like early-September 1992, we are about to move into a period of well-known poor seasonality, which some of you may know as “sell in May and go away.”
If the AAII survey is representative of retail investors sitting on the sidelines for the time being, as they did for weeks in September 1992, the heart of earnings season presents another potential headwind for bulls, who might be depending on corporate buybacks to support stocks in the days ahead.
Companies are bound by insider trading rules like everyone else and, therefore, will tend to suspend buyback activity in the 10 days preceding and the two days following an earnings release. Therefore, corporations buying back stock during the current pull back is not necessarily a given in the immediate days ahead.
Finally, in assessing the action of option buyers, the unwinding of an extreme in pessimism that resulted in a strong, short-term rally is showing evidence of already running its course. Per the chart below, note that the 10-day SPX component put/call volume ratio is turning higher again.
The new upswing in this ratio is from a relatively high level compared to what we are used to seeing in this bull market. But it is turning higher from lows that are typically seen in lengthy – dare I say it - bear markets, like that of 2007 – 2009.
“…if following the historical script and applying to the present, the SPX’s 4,375 level should be your ‘uncle’ point to take action to lighten up on bullish positions you may have initiated coincident with the SPX breakout… If you want to give a little more room, or lighten up even further if the SPX declines, the round 4,300-century mark is another point to focus on, as this represents September and January support.”
-Monday Morning Outlook, March 28, 2022
“From a short-term technical perspective, the SPX remains situated in the middle of what could be resistance levels overhead and strong support levels below... I cannot say with 100% certainty if the lows for the year are in place. If the SPX moves below the support area described above, shorts would likely be emboldened again. Amid low historical short interest on SPX components, a massive headwind would present itself if the shorts get bolder following a technical breakdown…If you want to hedge against a bearish scenario with index or exchange-traded fund (ETF) options, now is the time, with the CBOE Market Volatility Index trading in line with 63-day historical volatility and roughly half this year’s intraday high.”
-Monday Morning Outlook, April 11, 2022
Amid more potential short-term headwinds for bulls on the heels of last week’s decline, the SPX is edging closer to what could be “make or break’ levels from a longer-term perspective, as discussed during the past couple of weeks and as seen on the chart below.
The first important area that is important for bulls to defined is in the 4,375 zone, which is the level from which the SPX broke out above the top rail of a multi-month bearish channel in March. A move back below this level would seriously put the durability of that breakout into question and move the needle back in favor of the bears.
As I alluded to a couple of weeks ago, if indeed last month’s rally was just an impressive advance in what proves to be a prolonged period of equity market weakness, a move back below the March breakout level would be the first signal for longer-term weakness, if history is any guide.
But if you need more evidence, the final straw would be a notable break below the 4,300-century mark, which was support at the September and January lows. A break of 4,300 would likely result in a retest of the 2022 lows at least.
Last week’s advice still stands if you want to take the guess work out and use portfolio insurance to guard against a breakdown in equities. Although portfolio insurance is a little more expensive now relative to last week, it is reasonably priced with the Cboe Market Volatility Index (VIX) at 22.70 last week, slightly above 63-day SPX historical volatility of 21.50.
Todd Salamone is Schaeffer's Senior V.P. of Research
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