Long-term optimism can have a disastrous effect on markets
With the uncertainty of stock market trading, we as investors are always looking for the latest and most accurate technical data analysis to help us maximize profit from the smallest risk possible. This week, I wanted to take a look at a popular sentiment indicator that might explain the current investor proclivity for optimism, while also offering a cautious eye to the future. Specifically, Investors Intelligence, the oldest provider of technical research, releases data on the percentage of bulls and bears that are currently trading, signaling the amount of optimism currently being funneled into the market. With data and insight from Schaeffer’s Senior Quantitative Analyst Rocky White, we were able to compare bull, bear, and correction data from 2005, to the most recent reading from Investors Intelligence.
Compared to each of their long-term averages, bulls are currently higher with a reading of 57.4% versus its 48% average, while bears are lower with a reading of 18.8% and an average of 24%. The bulls minus bears line remains above its 25% average, with a reading of 38.6%. To put this into perspective, we typically consider a reading above 40% a sign of extreme optimism. Also worth noting is that the poll has had a reading of over 50% with bulls for 44 straight weeks. This of course suggests a lot of optimism, and tracks with the broader-market growth we have seen in the last 12 months.
That being said, White then looked at past times when the poll showed over 50% bulls for 44 straight weeks. It has only happened one other time, in early 2004, and the market performed poorly going forward, dropping more than 3% within the next six months. However the market did rebound after this pullback, eventually showing a 5.8% gain over the next year. That time, the poll was above 50% bulls for 46 straight weeks before it again fell below 50%.
For the S&P 500 Index (SPX) specifically, the bulls-bears percentile rank from the Investors Intelligence poll rose to 38.6% within the last week, putting it in the 89th percentile of all readings since 1972. When in this high of a percentile, the index sees 355 returns, but all in the red one, two, four, and eight weeks out. In simpler terms, pent-up optimism tends to spill over, and contrarian traders should take actionable steps to hedge should they remain optimistic about long-term market viability. As it pertains to the current investing climate, the most recent reading could be an indication that we’re susceptible to a sharp pullback if all these bulls suddenly turn bearish.
Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, March 28.