3 Signs Trump Optimism Has Peaked In the Stock Market

The number of Investors Intelligence (II) respondents who foresee a correction in the stock market rose to the highest point since mid-November

Mar 9, 2017 at 2:14 PM
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Unless you live under a rock, you're probably aware that the stock market has been on a tear since the U.S. presidential election, with the broader indexes just off all-time highs. However, while investor sentiment was trending toward a bullish extreme, recent indicators suggest stock traders are starting to exercise a bit more caution. Below are three signs the "Trump Optimism" may have peaked.

II Traders Calling for a Correction at Post-Election High

In the latest Investors Intelligence (II) sentiment survey, the percentage of self-identified bulls fell 5.4 percentage points to 57.7% last week, after touching a 30-year peak the week prior. The percentage of self-proclaimed bears rose by less than a percentage point to 17.3%. However, the bulls-minus-bears line remained above 40% for the 12th straight week, at 40.4% -- in the 93rd percentile of its annual range. Historically, this has been the "sweet spot" for the S&P 500 Index (SPX) in the short term, with the index averaging an eight-week gain of 2.56%, going back to 1972, according to Schaeffer's Senior Quantitative Analyst Rocky White.

investors intelligence ii spx returns chart

Meanwhile, the number of II respondents who foresee a correction in the market jumped 4.6 percentage points last week, to 25%. That's the highest since mid-November, just after the presidential election, snapping a 14-week streak beneath 25%. It's interesting to note that in the 10-week stretch from mid-September to mid-November, no fewer than 25% of II respondents foresaw a correction in the market, reflecting the surge in optimism triggered by the election.

AAII Bears Highest Since Stock Market Lows of 2016

Echoing that, the American Association of Individual Investors (AAII) weekly sentiment poll showed a large spike in self-identified bears last week. Specifically, bears jumped 10.9 percentage points to 46.5%, marking the highest level of skepticism since the stock market lows of February 2016. As such, the number of AAII bulls dropped 7.9 percentage points last week, to 30%, while those identifying as "neutral" dipped 3 percentage points to 23.5%.

But, even though we've been in a bull market for eight years now, AAII bulls haven't topped 50% since January 2015 -- 114 weeks, which is a record (going back to 1987). In the aftermath of the previous record streak, stock returns were very strong, hinting at the merits of a contrarian trading approach. Specifically, following the 110-week streak from January 1993 through February 1995, the SPX went on to add 14.4% in the ensuing six months. Going out one year, the broad-market index was up an astounding 35.3%.

Shorts Creep Back In After Post-Election Covering

In more evidence that the Trump Optimism might be wavering, short interest on SPX stocks recently turned higher for the first time since mid-November. As Schaeffer's Senior V.P. of Research Todd Salamone noted in this week's Monday Morning Outlook, "To the extent shorts begin to build positions again, this former tailwind becomes a headwind."

However, he added, while you should "beware that the shorts are getting a little bolder at these levels, and could become very aggressive if any major disappointments or negative surprises emerge out of Washington in the coming weeks," this doesn't necessarily mean the rally is ending. In 2015 and 2016, in fact, "upticks in short interest occurred during periods of market weakness," and money coming off the sidelines can still overpower the shorts.

SPX stocks short interest

In conclusion, Salamone advises to "respect the market's momentum, and stay the course with regard to bullish positions." Those hesitant to get into a long trade or who are concerned about a correction may want to manage risk with the "stock replacement" options strategy. This strategy consists of trading stock ownership for in-the-money call options, allowing traders to enjoy additional upside without putting everything on the line.

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