Analyzing Investor Sentiment After the S&P 500 Notches a Record High

Sentiment polls are strangely skewed in opposite directions

Senior Quantitative Analyst
Aug 26, 2020 at 8:00 AM
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The S&P 500 Index (SPX) closed above its previous all-time high last week, marking the official end to the COVID-19 stock crash. The index has rallied about 50% in five months, erasing the stock market losses caused by the pandemic. I figured it’s timely to study how investors have reacted in the past when the broad-market index makes its first new high in some time. Also, I break it down by the sentiment of investment newsletters, as well as retail investors who have opposing outlooks.

New All-Time Highs

First, I studied how the S&P 500 has performed after reaching an all-time high for the first time in at least 100 trading days. The second table is for comparison. It shows typical market returns since 1954, the year of the first signal. I could see this as a popular spot for profit-taking, in which you would see underperformance, or a continuation of momentum, which would lead to outperformance. Looking at the average return, however, it’s close to the usual market performance. The returns have been consistent, as measured by the percent positive and standard deviation of the returns. Looking at the individual time frames, the index has slightly outperformed two weeks and six months after the all-time high but slightly underperformed at those middle time frames of one and three months. Simply put, there’s nothing exciting to see here.

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Opposing Sentiment Polls

Two sentiment polls that we follow to gauge investor sentiment are showing different outlooks on the market. The sentiment survey conducted by Investors Intelligence (II) is showing a lot of optimism. The II poll is a study of over 100 published newsletters in which the editors determine the percentage that are bullish, bearish, or expecting a correction. In the latest poll, 59% of newsletters were bullish, which is an extremely high level. I broke down the SPX’s performance after all-time highs based on whether the percentage of bulls in the II poll was above or below 50%. The II poll goes back to 1963, so any signals before then are disregarded.

Supporting our contrarian philosophy, when the poll has shown a lot of optimism after an all-time high, it has led to underperformance. When the II poll shows over 50% of the newsletters as being bullish and then the S&P 500 hits an all-time high, the index has averaged a 1% loss over the next three months, with four of the seven results positive. In the other 11 instances of the index hitting an all-time high where less than half of the newsletters were considered bullish, the three-month return is an average gain of 1.6% with about 82% of the returns positive.

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A second sentiment poll we monitor is one conducted by the American Association of Individual Investors (AAII). That poll asks its members whether they are bullish, bearish, or neutral on stocks over the next six months. Only 30% of its members said they were bullish in the latest poll. So, unlike the II sentiment survey, this poll is showing pessimism on stocks.

I broke down the SPX’s returns after an all-time high based on whether the percentage of bulls in the AAII poll was above or below 35%. These results do not support the contrarian philosophy. The more bearish this poll has been, the worst the returns have been going forward. When less than 35% of the members have been bullish – like right now -- the index has averaged a loss of more than 3% three months later with only two of the six returns positive. When the percentage of bulls has been higher -- over 35% -- the index has averaged a gain of 2.6%, with four of the five returns positive. Both polls are bad news for what to expect in the near future.

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Naturally, I wondered if our current situation had ever occurred before. Specifically, I wondered if there had ever been a new all-time high when the II poll showed over 50% of newsletters were bullish while less than 35% of AAII members were bullish. This happened one other time, which was July of 2016. After that date, the S&P 500 made a move higher by 2% over the next month, but then pulled back so the three-month return was only 0.8%. From there, stocks increased with the S&P 500 showing a 6.2% gain six months after the all-time high.

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