Sentiment Survey Sounds Bearish Alarm

The AAII survey has shifted to bullish from bearish

Senior Quantitative Analyst
Jan 19, 2022 at 9:49 AM
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The members of the American Association of Individual Investors (AAII) seem nervous given recent market performance. The report date for the last survey was last Wednesday, when the S&P 500 Index (SPX) closed less than 1% away from its all-time high. With the pullback over the last few trading days, I expect even more pessimism in the next report. In the analysis below, I explain what the AAII survey is, before exploring whether stands up as a reliable contrarian indicator.

Methodology & Latest Reading

The AAII sentiment survey is a simple survey of its members, asking where they see the market going in the next six months. Members simply click bullish, bearish, or neutral, based on their predictions. It’s not a question of how portfolios are positioned, and no money or even reputation is at stake. Because this survey is volatile and represents the fleeting thoughts of investors, I consider its implications only in the short-term.

The chart below shows the SPX along with the percentage of bulls in the AAII survey, minus the percentage of bears. The recent reading fell back below the -10% line, meaning there were at least 10% more bears than bulls. It’s worth noting that this was reported before the pullback over the past few days. Bears outpaced the bulls by 10%, despite the SPX being very close to its all-time high.

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Quantifying Historical Results

We have AAII survey data going back to mid-1987. Since then, there have been 143 other instances where the bulls minus bears line went from above the -10% line to below it. The table below shows SPX returns after these occurrences, while the second table shows returns after all the AAII reports since 1987.

The average and median returns are higher in the short-term after these instances, compared to typical returns for the SPX. This supports the theory this is a short-term bullish signal. A month after the bulls minus bears line falls below -10%, the SPX averaged a gain of 1.11%, with a median return of 1.84%.

After any AAII report, the index gained an average of 0.70%, with a median of 1.17%. According to these numbers, a signal does not increase the chance of a positive return, however. The returns six months after a signal are similar to the anytime returns.

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One reason this report stuck out to me was the fact that the SPX was so close to an all-time high. Instinctively, I would expect the implications after a signal to be more bullish after it occurs closer to a record. I ran the numbers, however, and found my intuition was wrong.

To arrive at that conclusion, I looked at when the bulls minus bears line fell below the -10% mark, and the SPX was within 2.5% of an all-time high. This was the case last Wednesday, which was also the day of the last AAII report.

In these instances, the AAII members predicted correctly. The SPX averaged a loss out to a month after these occurrences, with right around half of returns positive. Looking specifically at the one-month returns, after an occurrence with stocks near an all-time high, the SPX averaged a -0.08% returns, with 53% of the returns positive. After an occurrence in which the index was farther away from an all-time high, the SPX averaged a gain of 1.42%, with 68% of the returns positive.

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I did not expect to get these results when I broke it down by how close the SPX was to an all-time high. I was expecting this study to be in the short-term bullish file, but upon seeing those final two tables, it certainly doesn’t belong there.


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