S&P returns tend to outperform the norm after individual investors hit this type of pessimistic extreme
By last Thursday morning, when the latest weekly sentiment survey results from the American Association of Individual Investors (AAII) were released, the S&P 500 Index (SPX) was well on its way to ending the month of May on a loss of over 5% -- not quite as gruesome as the 9.2% plunge that rattled the S&P in December, but resoundingly negative nonetheless (and moreover, the index's first negative monthly performance of 2019).
Given the context of that bearish price action for equities, it was not especially surprising to see that the percentage of bearish AAII respondents jumped by 4 percentage points in the week ended last Wednesday, May 29, to arrive at 40.1%. That's well above the survey's historical average of 30.5% bearish, just as the current percentage bullish of 24.8% rests firmly below its own historical mean of 38.5%.
In fact, just as the S&P was on track to record its worst monthly performance since Dec. 31, 2018, respondents in the AAII poll registered their highest bearish percentage since Jan. 2, 2019 -- suggesting the current level of pessimism in this survey mirrors that achieved around the time of the last significant stock market low. And from a broader perspective, Schaeffer's Quantitative Analyst Chris Prybal reports that this is only the 37th time that AAII bulls have numbered fewer than 25% while AAII bears have simultaneously exceeded 40%, which further supports the case for a relative extreme in pessimism among retail-level investors.
The S&P returns following those prior signals are remarkable -- if, again, not especially surprising to those who are already familiar with the principles of contrarian sentiment analysis. The index boasts an average four-week return of 2.05% post-signal, compared to its "at any time" return of 0.65% over that time frame since 1989. Likewise, the S&P's average 13-week return after a signal is 4.18%, roughly doubling its own "anytime" 2.10% return, and the mean 26-week return is 7.04%, outpacing the average 4.18% performance over a typical half-year period.
The percentage of positive returns is also higher than average over all three time frames following a signal, ranging from 72.22% over four weeks (versus 62.42% anytime) to 77.14% over 26 weeks (versus 73.57% anytime).
While it's only one data point among many out there right now, the unequivocally bullish implications of this AAII sentiment signal are certainly on our contrarian radar right now. Traders should continue to keep an eye on the high-stakes chart levels that are currently in play, because a breakdown in the technical backdrop would provide a legitimate damper to investor sentiment -- but any well-received fundamental news or unexpected technical resilience from equities could help turn the wheels in motion for another post-signal rally for stocks.
Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, June 2.