One of the most widely watch barometers for investor sentiment is the AAII survey, as it seems to capture the essence of the armchair investors’ sentiment at the moment. Technical guru Carl Swenlin has been watching the AAII numbers, and is concerned at the high bull to bear ratio we’re seeing today.
Sentiment Becoming Too Bullish
by Carl Swenlin
One of Thursday’s stories on CNBC.com had to do with some pros getting out of stocks because sentiment is becoming too bullish. Bullish sentiment can be a sign that an important market top could be lurking just around the corner, so let’s look at one of our sentiment charts to see how bullish things are getting.
(This is an excerpt from the January 27, 2012 blog for Decision Point subscribers.)
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The American Association of Independent Investors Investor Sentiment poll shows that the percentage of bulls has been running around 50% for the last four weeks. More significant is that the percentage of bears has shrunk to under 20% for most of that same period. The result is that the ratio of bulls to bears has been unusually high compared to most readings going back into 2005.
While sentiment has reached very bullish levels, we can see on the chart that this will mean different things depending if we are in a bull market or a bear market. Note the high bull/bear ratio at the end of 2010 did not really nail a market top. Rather the market did continue higher and an important price top did not occur for several months. Conversely, the bull/bear ratio peaks in October 2007 and April 2008 nailed the top of the bull market and an important bear market top respectively.
So, should we be concerned about the current high readings of the AAII bull/bear ratio? Currently, our objective measures tell us we are in a bull market, so we have to assume that bullish sentiment is not necessarily a problem. Of course, this could be the top of the bull market as we saw in October 2007, but we have no way to know that at this point.
Bottom Line: High readings of bullish sentiment do not always announce major price tops, but it is a flag that says perhaps extra caution is warranted. While it is a shame that high bullish sentiment is not a highly reliable top picker, I think it is useful to understand that we must interpret extreme indicator readings in the context of the kind of market, bull or bear, in which they appear.
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Technical analysis is a windsock, not a crystal ball.
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Carl Swenlin is a self-taught technical analyst, who has been involved in market analysis since 1981. A pioneer in the creation of online technical resources, he is president and founder of DecisionPoint.com, a premier technical analysis website specializing in stock market timing, market indicators, charting, and focused research reports. Mr. Swenlin is a Member of the Market Technicians Association.
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