Bullish Investor Sentiment Now Exceeds 2007 Stock Market top, According to Latest AAII Poll

Bullish Investor Sentiment Now Exceeds 2007 Stock Market top, According to Latest AAII Poll

Investors sure are in a good mood this Holiday season!  But how long can this extreme bullish mood last?  We turn to Sy Harding for his thoughts as we head into the Christmas holiday…but a quick heads up, these exuberant individual investors may have you reaching for the egg nog!


’Tis a Season To Be Jolly!

Being Street Smart

Sy HardingSy Harding

December 23, 2010.

The latest reports show the University of Michigan’s Consumer Sentiment Index rose in December to its most optimistic level since June. The survey’s director also said “The overall tenor of consumers regarding recent economic developments is more favorable than at any time in the last six years.”

And why not?

After sagging in the summer months to a degree that had the Federal Reserve step in during September with a promise of additional stimulus, economic reports have been quite positive in the last two months. Just this week it was reported that the economy grew at an annualized rate of 2.6% in the third quarter, better than the previously reported 2.5%. It was also reported that retail sales were up 0.8% in November, better than forecasts. Industrial output rose 0.4%, better than forecasts. Home sales rose more than 5% in November. Home prices even rose fractionally. And mortgage rates fell this week after five weeks of rising.

So consumers have good reason to be encouraged.

And it’s not just consumers who are finding this a season to be jolly. So are investors.

After being down for the month of November, the stock market resumed its uptrend in December, reaching its previous high last week, and rising further to new highs this week. After being down 16% in its April to July correction, the Dow has rallied back smartly and is now up 11% for the year, while the Nasdaq is now up 17% for the year.

For all of last year, and most of this year, even as the impressive new bull market in stocks continued, investors pulled money out of U.S. stock mutual funds at a dramatic pace, and poured money into bonds and bond funds as a safe haven at a near record pace.

Both of those trends have reversed. The outflow of money from stock mutual funds finally reversed to inflow in October, while the inflow of money into bond mutual funds has reversed to outflows over the last four weeks, and accelerated last week in the largest weekly bailout from bonds since October, 2008 (which took place just before bonds began a huge rally in November, 2008).

Investor sentiment for stocks has been becoming more bullish since September, until the poll of its members by the American Association of Individual Investors (AAII), reached a reading of 57.6% bullish in mid-November, its highest level since 2007. It then pulled back some but remained at a high level, above 50%. And this week it spiked up again, to 63.3% bullish, while the percentage of bears dropped from 27.1% to just 16.4%.

So, investors are also enjoying a high degree of optimism.

And why not? As I noted in last week’s column, next year is the third year of the four-year presidential cycle, and there has not been a negative third year of a president’s term since 1940. Next year also has the support of an improving economy, and the Fed providing additional fiscal easing to make sure the economy doesn’t falter.

But yet – while still enjoying the season, the level of investor complacency is a cause for concern, especially given the market’s overbought condition above key moving averages.

It has my own confidence in the market cooling off. Investor sentiment is a ‘contrary’ indicator, at extremes of bullishness and optimism at rally and market tops, and extremes of bearishness and fear at important lows and buying opportunities.

As noted, this week’s AAII poll has spiked up even further to 63.3% bullish, only 16.4% bearish. That’s a spread of 46.9%. Bullish sentiment was already higher than at the market’s April top this year, and the more serious bull market top in October, 2007. These latest readings are not good. While it’s wonderful to have consumer confidence growing, since consumer spending accounts for 65% of the economy, it is not usually wonderful to have investor sentiment at high levels of optimism, as they are usually associated with rally and market tops.

The spread between bullishness and bearishness in the AAII poll is currently 46.9%. At the important market low in early March of last year, which marked the end of the 2002-2007 bear market, the spread was minus 51%, with 70% bears and only19% bulls.

Yes, investor sentiment is a contrary indicator when it reaches extremes in one direction or the other, the market usually moving contrary to what the majority expects.

I’m still 80% invested, with no downside positions except against bonds, which have been plunging, and for which we’ve had a sell signal for awhile. And I don’t want this joyous season for stocks to be interrupted. But investor sentiment and the market’s overbought condition says it will pay to be alert for potential changes as we swing into the new year.

However, right now it continues to be a joyous season.

Merry Christmas and Happy Holidays!

Sy Harding is editor of the Street Smart Report, and the free market blog, www.streetsmartpost.com.