5 Signs of Extreme Optimism on Wall Street

The number of AAII bulls has grown for 5 straight weeks -- something that hasn't happened in 5 years

by Andrea Kramer

Published on Dec 21, 2017 at 3:10 PM

With tax reform all but guaranteed, not to mention bitcoin attracting a fresh set of investors, optimism on Wall Street has hit fever pitch. In fact, the American Association of Individual Investors (AAII) poll recorded its fifth straight increase in bullish respondents -- sending up a sentiment signal not seen in five years, according to Schaeffer's Quantitative Analyst Chris Prybal. Below, we examine four more signs of extreme optimism in the stock market, and how the S&P 500 Index (SPX) tends to perform after AAII signals.

4 Signs of Extreme Optimism on Wall Street

To start, 64.1% of Investors Intelligence (II) respondents consider themselves bullish -- much higher than the average bullish reading of 47% since 2005, according to Schaeffer's Senior Quantitative Analyst Rocky White. The bulls-minus-bears line jumped to 49.0% from 46.7% the week prior, putting it in the 97th percentile of all-time readings.

Meanwhile, domestic large-cap stocks recently attracted their biggest weekly inflows since April, per a recent BofA-Merrill Lynch report. Of the $7.8 billion in U.S. equity inflows, $7.6 billion went to large-cap stocks. On the other hand, the once-popular emerging market funds saw their biggest weekly outflows in 46 weeks.

CNN's Fear & Greed Index is now firmly in the "Greed" neighborhood, registering at 72. One month ago, the index was in the "Neutral" zone. Among the data points that make up the index, CNN notes that during the past five trading days, put volume has lagged call volume by 44.74% -- "among the lowest levels of put buying seen during the past two years, indicating extreme greed on the part of investors."

The National Association of Active Investment Managers (NAAIM) exposure index saw its biggest one-week point gain on record last week, jumping 51.02 points. On a percentage basis, the index surged 87.3%, marking its biggest since October 2015, per Prybal. For perspective, just a month ago, the NAAIM index was at its lowest point since May 2016.

NAAIM sentiment

AAII Also Shows Whipsaw Sentiment Reversal

It's a similar story with the AAII poll, which indicates a whipsaw reversal in sentiment on Wall Street. Just a month ago, the number of self-identified bulls plummeted by the most since April 2013. Now, the number of AAII bulls stands at 50.5%, marking the first reading above 50% since January 2015 -- the longest stretch ever. Since the 2009 bottom, there have been just 21 times (out of 458 weeks) in which bullish AAII sentiment was above the halfway point.

Last week was the fifth straight in which the number of AAII bullish respondents grew. The last time that happened was in November 2012. Since the beginning of the AAII sentiment poll in 1987, there have been just six other times in which the number of self-identified bulls increased for five straight weeks. Following the last signal, the SPX went on to gain 12.9% over the next six months.

AAII 5wk bull streaks

SPX after AAII signals

However, while stock market "euphoria" tends to mark tops (since little sideline cash is left to fuel the rally), previous surges in AAII sentiment haven't preceded weaker-than-usual price action. In fact, one week after the previous signals, the S&P was up 1.1%, on average -- more than five times its average anytime one-week return of 0.2%, looking at data since 1987.

In the same vein, the SPX has been positive 83% of the time one, three, and six months after these signals, which is much better than usual, and the broad-market barometer's average returns during these time frames are also much stronger. For instance, three months after a signal, the S&P was up an average of 5.1%, compared to 2.1% anytime.

SPX returns after AAII signals

Don't Forget Seasonality

Again, while traders should exercise some level of caution during times of heightened stock market optimism (stocks typically "climb a wall of worry," as they say), seasonality also favors the bulls right now. The S&P tends to outperform in the final weeks of the year; from Dec. 15 through the end of the year, the SPX averages a gain of 1.59%, and is positive 80% of the time. For speculators looking for short-term bullish opportunities, these 25 stocks could rally next week, if past is prologue.

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