The II and AAII sentiment surveys are showing wildly different stock market expectations
Stocks have done quite well since the first quarter of 2016, and the S&P 500 Index (SPX) is within a few percentage points of its all-time high. Therefore, it's not surprising that the weekly
Investors Intelligence (II) sentiment poll has shown a relatively high number of bulls recently. But then you look at the recent poll figures from the
American Association of Individual Investors (AAII) and see that they are much less optimistic.
The chart below shows the S&P 500 along with the eight-week average percentage of bulls in the II and AAII polls. You can see the II percentage recently hit 60% and is high, relative to the past several years. The AAII poll, on the other hand, shows the percentage of bulls relatively lower and falling. What does it mean when these polls diverge like this? Is one poll more reliable than the other? This week, I'll look at how stocks have acted in the past when these polls conflict like this.
The Two Investing Sentiment Polls
The two polls are quite different in how they are conducted. The II poll is a compilation of published newsletters that the editors at Investors Intelligence decipher as being bullish, bearish, or expecting a correction (this means short-term bearish, but long-term bullish). The AAII poll, on the other hand, is a simple question each week for its members. They simply answer whether they are bullish, bearish, or neutral on the stock market over the next six months.
The different methodologies for the polls make the AAII poll much more volatile than the II poll. Newsletters that have been published are much more likely to hold on to their past view so that they are eventually proven correct. The AAII poll is an anonymous survey, so it's much easier to suddenly go from bullish to bearish, or vice versa.
Quantifying the Sentiment Poll Results
To analyze the polls, I found the eight-week average of the percentage of bulls in each poll. I did this going back to late 1987, which is when we first have data on the AAII poll (for the II poll, we have data back to the early 1960s). I then made four brackets based eight-week averages of the percentage of bulls. Finally, I found the three-month and six-month returns, based on which bracket the bullish percentages were in. The current eight-week average of the bulls in the Investors Intelligence poll is 56.1% so it is in the highest (most bullish) sentiment bracket of returns. The AAII eight-week average of the bulls is at 32.6%, so its members are in the most bearish sentiment bracket. That's amazing to me, given the SPX is only a few percentage points from its all-time high.
There is a lot going on in the tables below, so let me explain a bit. As I mentioned, going back to 1987, I made four groups of returns based on the eight-week average of the percentage of bulls. I made groups so that there were an equal number of readings in each bracket. Each row represents a bracket.
The leftmost column shows the range of the percentage of bulls. The first row shows SPX returns after the percentage of bulls was between 26% and 41%. This is when the poll was showing the most pessimism. As you move down the table, the poll shows more and more optimism. You can see why these polls are considered contrarian indicators. The return data in the first two rows, when the poll shows the most pessimism, is far better than the return data in the last two rows, when it shows the most optimism. The bolded row indicates the current poll reading of 56.1%. Based on this poll, we should have some underperformance over the next three-to-six months.
Next, let's look at the AAII poll in a similar fashion. The current reading for the AAII poll is 32.6% which puts it in that top bracket. Again, when the reading is most pessimistic, you tend to get the best performance going forward. So, according to this poll, we could expect outperformance over the next three-to-six months.
Stock Performance When Sentiment Polls Conflict
So, when the II poll is showing all that optimism and the AAII poll shows pessimism, which one should we trust as the contrarian indicator to follow? For this, I looked at how the S&P 500 performed, depending on the overlap of return brackets. I numbered the brackets so that the most pessimistic bracket (the top row in the tables above) were bracket one, and the most optimistic bracket was bracket four. The first grid below shows the number of returns for each bracket grouping. Currently, the AAII poll is in bracket one and the II poll is in bracket four. The table below shows there have only been 23 similar occurrences.
In these 23 occurrences, the S&P 500 tended to underperform going forward. The index averaged a loss of 0.40% over the next three months. You can see the average return overall was 2.12%. The brackets surrounding the current bracket also underperform the typical return.
And this last table shows the six-month returns going forward. The S&P 500 Index (SPX) doesn't average a loss over the next six months, but it does tend to return less than the overall return.
