Trader’s Narrative

Way back in a January sentiment overview, I mentioned that the AAII bearish sentiment had reached a shocking 59% bearish level with bulls only 20%. According to historical data, this is very bullish because whenever the AAII bears go above 50% this is what happens:

Since 26 weeks have gone by, here is a chart showing what actually happened:

Since the extreme sentiment caught everyone’s notice, the stock market totally ignored it and went underwater. The only exception was when in mid-May it resurfaced for a blink of an eye to break even, only to descend into murky depths again.

The S&P 500 Index (SPX) finished down 11.5%. Not a resounding vote of confidence for sentiment. But that is the nebulous nature of sentiment. Trying to get a quantifiable edge from it is like trying to nail jello to the wall. So what happened?

Take a look at my previous analysis on bearish sentiment during a bear market. As you’ll see in the graphs in that article, there was a long lag between the occurrence of extremes in bearish sentiment and a lasting market bottom.

The nature of extremely negative sentiment is that it has a lag bear markets, while it doesn’t in bull markets. To see another example, consider that in the rolling 52-week time between 1990 -1991 the AAII gave 14 separate instances of bearish sentiment above 50%. Pull out your very long term charts and you’ll see the lag there. In contrast, consider the summer of 2006 where the market quickly bounced back.

Also, as I keep repeating, sentiment is only one leg of the table. The other three are technical analysis, fundamental analysis and fund flows.

If you haven’t already, make sure you check out the “Best Of” section for more interesting articles about sentiment, technical analysis and much more.