Key Sentiment Survey Flashes Rare Signal

There could be some underperformance in the long run

Senior Quantitative Analyst
Sep 8, 2021 at 8:00 AM
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A little over a month ago, I wrote about the sentiment survey put out by the American Association of Individual Investors (AAII). It showed pessimism in spite of the stock market's position near all-time highs. The AAII also surveys their members on a monthly basis regarding their asset allocation, which is currently noteworthy.

The chart below tracks the survey’s results. Their allocation to stocks is soaring along with the S&P 500 Index (SPX), while their bond and cash allocation is extremely low. In fact, looking at the data back to 1990, it’s the fifth lowest cash allocation we’ve seen. Theoretically, this is a cause for concern. It suggests optimism, and that investors are close to fully invested in stocks with minimal sideline cash to keep the rally going. As I often do, I’ll spend the rest of this piece analyzing whether the theory just mentioned has been observed historically.

Survey Results

The Data

Since I mentioned it’s the fifth lowest cash allocation reading since 1990, I included the table below of the lowest readings. You have a couple readings in the late 1990s, just before the tech bust, and then a couple more readings at the end of 2017 and beginning of 2018. Recall, the S&P 500 fell 6% in 2018. It’s not enough to draw any conclusions, but, unfortunately, it supports our bearish theory.

Lowest Cash

Here’s another way I looked at it. Going back to 1990, I looked at the bottom 10% of cash allocation readings. Summarizing the S&P 500 returns after these readings gives me the table below. The second table shows typical returns for the index since 1990, for comparison. This data is not scary at all. The returns in the first table are similar enough to the typical returns. A year after low cash readings, the S&P 500 averaged an 8.1% return over the next return with about 70% of the returns positive. That just slightly underperformed the usual 12-month return of 9.6% with 80% positive.

SPX After Low Cash

Next, I’m focusing on the stock allocation. Summarizing the stock returns after the highest 10% of stock allocation levels gives the data below. Again, the second table is for comparison. This data, looking at stock allocations, is a bit more worrying than the data above looking at cash allocation. The underperformance, though not catastrophic, is more pronounced than above. Further, 12 months after high stock allocations, the S&P 500 returns and average of 5.5% with 66% of the returns positive.

SPX After High Stock

Finally, I merge the two filters above into one. That is, I looked at times the cash allocation was in the lowest 10% of readings and the stock allocation was in the highest 10% of readings. That gives us the data below. It’s notable that the shorter-term one-month returns outperform the anytime returns handily. This could be a result of momentum. These asset allocations will typically occur during bull markets. Not only because investors get more optimistic, but even if traders do nothing with their portfolio, a rising stock market will increase their allocation to stocks because their stocks are becoming more valuable relative to cash. The longer-term returns, however, underperform anytime returns. This could be due to a limited supply of buying power as mentioned early in the article. While the underperformance might lower our expectations, the data doesn’t suggest abandoning the market. That’s the bright side.

SPX After High Stock and Low Cash


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