Despite consistently setting records, AAII isn't completely sold on the S&P 500 Index (SPX)
The S&P 500 Index (SPX) has been consistently hitting new highs for some time, but this hasn’t encouraged the membership of the American Association of Individual Investors (AAII). Every week, the AAII asks its membership how they feel about the stock market over the next six months. They can answer bullish, bearish, or neutral. The table below shows the SPX along with the four-week average of the bulls minus bears from their survey.
You can see the bulls minus bears line is negative, meaning a higher percentage of respondents answered bearish compared to bullish. This poll is often considered a contrarian indicator, especially when the results diverge from the direction of the market. In this article, I quantify the results and then break down the numbers to align with the current market environment.
Contrarian Market Behavior
To get the data below, I looked at AAII reports dating back to 1990. I grouped the dates by the 4-week average of the bulls minus bears line. Then I recorded the SPX return going forward at various time frames. Last week’s reading of the 4-week average of the difference was -9.4%, placing it in the second-to-last row of the table. The three weeks prior to last week, the AAII 4-week average was below -10%. So, it just moved out of that last row.
The low readings of our indicator have been good news for the SPX. For every time frame below, from two weeks to 12 months, the SPX had the best average return when the reading was below -10%. When the AAII membership has been the most bullish, we get the lowest return in each time frame, except for the three-month time frame. In short, the AAII membership is currently bearish on the market over the next six months, and this has been a bullish sign for stocks based on the data since 1990.
I want to give more context than just the average return. The table below uses the same buckets as above but gives more information about the SPX return over the next six months. I bolded the last two rows since the latest reading is -9.4%, barely into that second-to-last bucket, and recall, the three weeks prior, the reading was in the last bucket.
When AAII members were most bearish, the SPX performed the best over the next six months with an average return of 7.4% and a median return of 9%. When their members were most bullish, the index performed the worst with an average of 3.3% and a median of 4.2%. When the reading hasn’t been at those extremes, there’s been less variation in the market. The extreme readings are what you want to look out for. If you’re bullish going forward, another encouraging sign about pessimistic AAII membership is that’s when there has been the most potential for big upside. In those two bottom rows, when the AAII bulls minus bears average is negative, the average positive return is in the double-digits (13.4% in the last row and 10.3% in the second-to-last row).
In this last table, I show the same type of data as I have above, except it only looks at instances in which the SPX was within 1% of its all-time high. There are not a lot of extremely pessimistic readings, which isn’t surprising, as it’s hard to be too negative with the market at or near its highest point ever. That is, however, our current situation.
There have only been eight times where the 4-week average of bulls minus bears was below -10% with the market near all-time highs. The SPX performed well after those readings but it’s only eight data points. The second to last row has more readings and they are disappointing. In these instances, the SPX averaged just a 1.12% return over the next six months with 66% of the returns positive. It’s in this bucket that we also see the least upside with an average positive of 6.7% and most downside with an average negative of -9.65%. Some of the notable times in which the AAII membership was in this bucket with the SPX near a high was September of 2019, just before the COVID-19 crash and at the very end of 2021, just before stocks fell significantly through the first several months of 2022.
As a contrarian, I am encouraged by the AAII membership’s bearish tilt. Especially since their sentiment survey has been a reliable contrarian indicator. That said, the data on that last table makes me think I should temper my expectations.