Stocks tend to underperform after the gap between bulls and bears gets this wide
It was just about seven months ago -- and roughly 6% ago, in terms of S&P 500 Index (SPX) returns -- that we last discussed the significance of the so-called "bulls minus bears" measure in the weekly Investors Intelligence (II) sentiment survey. This metric, as literally as the name suggests, tells us how wide the gulf is between the number of bullish and bearish investment advisors in the II poll. When this number gets high, it tells us that bulls are starting to outnumber bears by an increasingly wide margin; we typically consider readings of 40% or above to represent extreme levels of optimism.
For the week ended Sept. 20, the percentage of II bulls increased to 55.1%, marking the fourth straight week of gains, and their third consecutive week above the 50% threshold. Bears, meanwhile, edged fractionally lower to 16.8%, while the remaining 28.1% of advisors anticipate a correction in the market. As such, the bulls-minus-bears reading has now arrived at 38.3% -- less than 2 percentage points from a bullish extreme, and in the 90th percentile of its all-time range.
Prior to this latest occurrence, there have been just four other times in the past year where the II bulls-bears reading has risen into the 90th percentile or higher. The first occasion was in late April, just ahead of the 6.6% May sell-off in the S&P 500 Index (SPX); the three remaining signals were all clustered in July, directly ahead of the four-week losing streak that shaved 5.9% off the S&P's value through the close on Aug. 23.
This is not to suggest that an S&P pullback in the ballpark of 6% is imminent after this latest 90th percentile II bulls-bears reading, but traders may well want to brace for some choppiness ahead. We have data going back to 1972, and Schaeffer's Senior Quantitative Analyst Rocky White reports that after the II bulls-bears line jumps to the 90th percentile or higher, S&P returns going forward lag the average "anytime" returns by a fair margin.
Specifically, the average one-week S&P return after a 90th percentile reading or greater is just 0.01%, compared to 0.16% anytime. By two weeks later, the index has managed a return of only 0.04%, versus 0.32% anytime; by four weeks, the S&P has slugged its way to a 0.11% return, compared to 0.64% anytime. And as far as eight weeks out, the broad-market benchmark averages a return of just 0.81%, lagging its typical 1.27% return for this time frame.
As usual, the weight given to this single sentiment indicator should be secondary to that assigned the actual S&P price action, but -- coupled with the similar cautionary signs flashed by the equity put/call ratio highlighted in this space just a week ago -- investors should strongly consider using options to manage risks in this market.
Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, September 29.