AAII Bears Just Hit a 6-Year Extreme

While the stock market has shown some serious strength in the process of snapping back from the Christmas Eve closing lows, the collective mood among investors and consumers has been somewhat less resilient. On Friday -- as the S&P 500 Index (SPX) was in the process of collecting a second consecutive close back above its 50-day moving average for the first time since early October -- the University of Michigan consumer sentiment index cratered to a reading of 90.7, marking its lowest point since October 2016 (and falling well short of consensus expectations along the way).

The UMich survey's chief economist said respondents attributed their gloomy mood to "a host of issues including the partial government shutdown, the impact of tariffs, instabilities in financial markets, the global slowdown and the lack of clarity about monetary policies." And given the breadth and depth of these uncertainties, it should come as no particular shock that Friday's dismal mid-January consumer sentiment index reading was directly preceded by a bearish surge in the American Association of Individual Investors (AAII) survey for the week ended Jan. 16.

Specifically, the percentage of bearish respondents in the AAII poll jumped by 6.9 percentage points to 36.3%, while the percentage bullish fell 4.9 percentage points to 33.5%. The percentage with a neutral outlook on stocks retreated 2 percentage points to 30.2%.

AAII bears reclaimed the majority after a two-week period that saw their ranks decline by 41.6% -- the largest such drop since Sept. 13, 2017, according to Schaeffer's Quantitative Analyst Chris Prybal. Meanwhile, AAII bulls returned to the minority after a four-week spree of optimism that had pushed the percentage of bullish respondents up by 84.2% -- from 20.9% on Dec. 12 to 38.5% as of the Jan. 9 survey date.

Given the week-to-week volatility in the AAII sentiment survey, Prybal maintains 10-week moving averages of the percentages of bullish and bearish respondents to smooth out and track longer-term trends in the data. Recently, the 10-week moving average of AAII bears crested above 40% for the first time since November 2012 -- revealing an extreme degree of pessimism among retail-level investors.

Going back to the survey's inception in 1987, Prybal found 12 previous instances where the 10-week moving average of AAII bears exceeded 40%. Following those prior signals, the average S&P returns over the ensuing four-week, 13-week, 26-week, and 52-week periods outpaced the index's comparable "anytime" returns over every time frame.

And since the bull market began in 2009, these AAII bearish extreme signals have been unequivocally positive for stocks over the long haul. The last four occurrences -- in October 2009, July 2010, October 2011, and November 2012 -- yielded 52-week returns of 13.4%, 23.9%, 26.8%, and 28.2%, respectively. Those numbers all compare quite favorably to the S&P's "anytime" average 52-week return of 8.8% since 1987.

Of course, the key phrase in the above paragraph is "since the bull market began." If the underlying price action remains as encouragingly robust as it's been so far in 2019, we could well see this latest AAII bear extreme unravel in the same broadly positive direction that it's played out in the past. But if the apparent "V-rally" that's shaping up for stocks should begin to fall apart -- thereby lending some technical weight to the bears' thesis -- the contrarian bullish implications of this latest signal would be greatly diminished.

Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, January 20.