Sentiment is very high: bullish for the stock market


AAII is the best sentiment indicator for the U.S. stock market. AAII Bulls have surged over the past few weeks to a reading of 60.

This is the first time investors have been this bullish in more than 3 years! Historically, this is a medium and long term bullish sign for the U.S. stock market. Here’s what happens to the S&P 500 when AAII exceeds 55 for the first time in more than half a year.
*Keep in mind that AAII data only goes back to 1987. It is an incomplete indicator that we don’t use in our Medium-Long Term Model.

  1. February 21, 1991: +7.8% 6 months later
  2. December 17, 1992: +0.54%  6 months later
  3. May 30, 1996: +13.14% 6 months later
  4. February 27, 1997: 1+3.74% 6 months later
  5. January 21, 1999: +10.75% 6 months later
  6. December 2, 1999: +3.07% 6 months later
  7. April 24, 2003: +14.47% 6 months later
  8. July 14, 2005: +4.86% 6 months later
  9. January 18, 2007: +7.24% 6 months later
  10. November 11, 2010: +11.56% 6 months later
  11. December 26, 2013: +6.49% 6 months later
  12. November 13, 2014: +4.06% 6 months later

As you can see, the S&P was higher 6 months later in every single case. This makes sense. When sentiment becomes excessively bullish, all dips are bought. The stock market doesn’t die on insanely strong momentum. It dies after momentum has weakened. This suggests that there will be no significant correction in the first half of 2018, which our Medium-Long Term Model confirms. Let’s look at each of these cases in depth.

February 21, 1991

The S&P began a 6.4% “small correction” 2 months later.

December 17, 1992

The S&P did not make a single 6%+ “small correction” in 1993. However, there were many pullbacks along the way (unlike in 2017, when the S&P made almost no pullbacks). 1993 was a very choppy year.

May 30, 1996

The S&P was in the beginning of a 11% small correction. The S&P continued to rally through 1996, although its rally wasn’t as steady as 1995.

February 27, 1997

The S&P was in the beginning of a 10.2% small correction. The S&P also continued to soar in 1997.

January 21, 1999

The S&P began a 7.1% small correction less than 4 months later. The S&P soared in 1999, but its rally was extremely choppy.

December 2, 1999

The S&P began a 10.3% small correction 1 month later. This was the beginning of a flat top, which marked the end of the S&P’s bull market.

April 24, 2003

The S&P did not make a single correction for the rest of 2003. HOWEVER, this case does not apply to today because the S&P was near the bottom of its previous bear market. We are in the final quarter of a bull market today.

July 14, 2005

The S&P began a 6.2% “small correction” 3 weeks later. The S&P generally went up in 2005, but it was an extremely choppy year.

January 18, 2007

The S&P began a 6.6% small correction 1 month later. The S&P made a rather flat top in 2007, which marked the end of the bull market.

November 11, 2010

The S&P continued to rally nonstop (no pullbacks) and began a 7% “small correction” 3 months later.

December 26, 2013

The S&P began a 6.1% “small correction” less than 3 months later.

November 13, 2014

The S&P began a 15.2% “significant correction” half a year later.

Conclusion

Insanely bullish sentiment is a medium-long term bullish sign. However, it generally means that the U.S. stock market will experience increased volatility over the next few months. Here’s why I think the stock market will make a “small correction” in Q1 2018.

2 comments add yours

  1. Hi Troy,
    Earlier in this article, you stated, “This suggests that there will be no significant correction in the first half of 2018, which our Medium-Long Term Model confirms” but in the conclusion, you’re still looking at a “small correction” based on historical data.
    Just curious, at what point we stop waiting for a new entry point (“small” correction) and just get back into the market.
    Thanks!
    Shawn

    • I don’t know Shawn. That’s up to you. From a pure probability perspective, the longer you wait the more likely a small correction will begin. In my personal portfolio I don’t trade small corrections. Only watching out for significant corrections.

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