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Bearish sentiment in the market has dropped to 19.6%, according to a recent AAII survey.
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Market pessimism is “unusually low.” That’s often followed by below average six-month returns in the S&P 500.
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“When extremes in bearish sentiment are reached, it’s normally wise to be patient on initiating new positions,” Fundstrat said.
Wagering that the Federal Reserve is done hiking interest rates, market bulls have staged a strong November rally. At the same time, the number of bears in the market has dwindled to potentially alarming levels.
The latest American Association of Individual Investors survey this week shows that market pessimism has dropped to its lowest level in nearly six years. Bearish sentiment dropped to 19.6%, compared to the 48.8% of market bears, a wide gap that’s relatively unusual.
“Pessimism is unusually low, at its lowest level since January 3, 2018 (15.6%), and is below its historical average of 31.0% for the fourth time in 11 weeks,” the AII said on Thursday.
A low level of bearish sentiment and a higher number of bulls in the market might sound like good news for stocks, but that’s not necessarily the case. Sentiment readings are contrarian indicators and a high level of bullishness could mean that the market rally may run out of steam soon.
Periods of unusually high optimism and low pessimism have historically been followed by below-average six-month returns in the S&P 500, the AII release noted.
In November, the benchmark index gained 8.9%, placing it in the top 20 months of the S&P 500’s performance since 1950, data from LPL Financial showed.
According to Fundstrat analyst Mark Newton, the number of bears in the market right now is “alarmingly low.”
“While the 4th Quarter normally results in heightened levels of bullish sentiment, I view this escalation to be concerning given that Technology and Financials sector ETF’s are right near resistance while the VIX recently plunged under 12.50,” Newton said in a note on Thursday.
Other sentiment gauges are also showing low levels of pessimism among investors. The Investors Intelligence sentiment index recorded 55.7% bullish versus 21.4% on Tuesday, and the CNN’s Fear and Greed Index is pointing towards “Greed,” after tilting towards “Fear” for months.
“Overall, sentiment is certainly just one piece of the market puzzle,” Newton said. “Yet when extremes in bearish sentiment are reached, it’s normally wise to be patient on initiating new positions for those with shorter-term timeframes, particularly following a 10% rally in the last five weeks.”
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