Are Investors Too Bullish on Stocks?

By: Clif Droke | Sun, Nov 10, 2013
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Just how far has the bullish sentiment of independent investors recovered since the 2009 bottom? Pretty far indeed.

Below is a chart showing the cumulative AAII investor sentiment going back to 2006. As you can see, the typical small investor had a mostly bearish outlook on stocks from late 2007 through the end of 2009. The small traders then turned slowly bullish on equities in 2010 and have been increasingly more enthusiastic about stocks ever since. As of last week, this indicator made a new multi-year high which shows you just how much investor sentiment has rebounded. This has caused many to wonder if investors have become too bullish on stocks.

AAII Investor Sentiment Chart

Yet for all this, the public at large is still missing from this remarkable rebound. It's mostly high-net-worth investors that are the driving force behind this bull market. The general public has exposure mainly in the form of 401Ks, but gone are the days of day trading and direct investment. The average retail investor (i.e. the general public) never quite regained the same appetite for equities he had in the years prior to the credit crash. Yet high-net-worth investors are as bullish as they have been in years. So is the typical Wall Street pro. But is this enough to put a top on the market (from a contrarian standpoint)?

Consider that in the years since the 2009 bottom there have been at least three notable corrections: the "flash crash" in May 2010, the 2011 mini-bear market, and the April-June 2012 correction while the master weekly Kress cycle was bottoming. Each of these setbacks occurred on low public participation. It's clear that the stock market has largely become a rich man's playground since the credit crash and Wall Street is basically just playing against itself, not the public at large. So the answer to that question is yes, stocks can "correct" substantially even without widespread public participation.

The next question that comes to mind is, "But doesn't history show that major bull markets don't end until the public has maximum exposure to stocks?" This is a true observation, so there is some question as to whether the recovery that began in 2009 will continue, albeit with fits and starts, after the 60-year cycle bottoms in 2014 and until the public finally embraces the bull. Quite simply, this is a matter of speculation and unfortunately technical analysis, with its short-term focus, offers no conclusive answers. But the odds are still in favor of 2014 witnessing another broad market correction - the first in over a year.

So while the general public remains ambivalent toward equities, the current participants - which include large speculators and institutional investors - are as bullish on stocks as they've been all year. The CNNMoney Fear & Greed Index is currently at 71, its highest reading since the September peak. The AAII bull-bear ratio is currently at a level which in the past has suggested too much optimism and has heralded market pullbacks (see chart below).

AAII Bull-Bear Ratio Chart

Consider also the current state of investor sentiment as reflected in Citigroup's Panic/Euphoria Model. The indicator is currently reflecting a state of "euphoria," as defined by Citigroup's admittedly loose methodology. The indicator is not without merit however: it correctly predicted the previous pullbacks of February, May-June and August.

Citigroup Market Sentiment Chart

It must be emphasized that none of the above mentioned sentiment indicators can pinpoint a market top with any precision. Rather, they should be viewed as "heads up" indicators to prepare us for a potential market juncture in the near future.

 


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Clif Droke

Author: Clif Droke

Clif Droke
ClifDroke.com

Clif Droke is a recognized authority on moving averages and internal momentum. He is the editor of the Momentum Strategies Report newsletter, published since 1997. He has also authored numerous books covering the fields of economics and financial market analysis. His latest book is Mastering Moving Averages. For more information visit www.clifdroke.com

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