This is What Contrarians Don't Want to See

Investment advisors are way more optimistic than we'd like to see

Senior Quantitative Analyst
May 6, 2015 at 7:53 AM
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As contrarians who focus on investor sentiment, we keep an eye on an assortment of sentiment polls.  This week, I'm taking a look at the Investors Intelligence (II) weekly sentiment survey.  I'm analyzing it differently than how I've seen it presented elsewhere. 

First, it's useful to know the methodology of the poll we're looking at.  The editors at Investors Intelligence collect over 100 published newsletters, email bulletins, etc. from investment advisors and determine the percentage that are bullish on the market, bearish on the market, or expecting a correction.  They classify correction as short-term bearish, but longer-term bullish.  They admit there is some subjectivity to this method, but they've only had four different editors since they began the poll in 1963, so there is some consistency to their approach.  I think looking at newsletters will give this poll a natural bullish tilt, since those publications do best, I'm sure, in bull markets, when more people are interested in -- and invested in -- the stock market. 

Below is a chart showing the weekly poll results since 2005 along with the S&P 500 Index (SPX).  As you can see, there are currently a lot of bulls and very few bears.  Contrarian investors would prefer to see less bullishness than this.  However, keep in mind the market has been very strong over the past six years, so some bullish sentiment is natural.  The implications of bullish and bearish sentiment are much stronger when it's counter to the market trend rather than with it.         


Rocky 1

We often take the percentage of bulls and subtract the bears to get a difference of the bulls and bears.  This gives us just one line to keep track of.  That line is in the chart below.  We've typically considered a difference of 40% extreme optimism.  However, over the last couple of years, 40% has not been all that uncommon.   


Long-Term Average​: I wondered if the poll had ever shown such a consistently bullish outlook.  I decided to take a longer-term average of the poll results.  The chart below shows data since 1975 for the SPX and of the 52-week averages of the II poll results.  As you can see, the average bulls over the past year is at its highest point since 2005, while the percentage of bears is at its lowest point in 38 years!  The lack of bears in this poll might be a little worrisome, but it might provide a little comfort that the percentage calling for a correction is at a very high level.  At least there are short-term bears.            



Here's a chart showing the spread between the 52-week averages of the bulls and bears.  Once again, you need to go back to 1977 to find a spread as high as it is currently (the spread of the 52-week averages is 37.9%).  There is a lot of stock market optimism, according to this poll. 



Finally, I wanted to get some quantified results about what the current level of optimism means.  To do that, I broke down the forward-looking returns on the SPX into 10 different brackets depending on the 52-week average of the difference in the bulls and bears.  The colorful table below shows the results.  Currently, the difference is in the 98th percentile of readings since 1975.  Therefore, the relevant bracket to look at right now is the "90 – 100" row, which is at the bottom of the table.  As you move up the table, the returns correspond to less and less optimism.  As a contrarian would expect, the best returns in the table are near the top.  That's especially true when you look at the longer-term returns.   Interestingly, the worst returns are more toward the middle of the table, in the 50-60 and 60-70 brackets, rather than the very bottom of the table.  However, this poll is showing extremely optimistic stock market advisors, which should be at least a bit worrisome. 


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