What the AAII Individual Investor Sentiment Survey Says About the U.S. Stock Market

Published on 9-03-2015: These comments are supplemented with “Tweets/StockTwits” (see links below) as well as my weekly weekend posts and needed intra-week updates.

UPDATE 9-10-2015: Investors Still Complacent.

Despite the gyrations, investors remain complacent with the number of Bulls 34.65% vs. 35.01% Bears for a spread of 0.36% this week.  The SP500 Chart improved a bit as noted on Twitter/StockTwits today with my latest buys. 

Please see the chart posted here: Up or Down?  I say the tone is more up than down.  Read the warning below by all means, because NO ONE can actually predict the market’s reaction next Thursday Sept. 17th to the Fed raising 0.5% vs. 0.25% vs. 0%.  Any of those is possible given the current backdrop.  The risk of raising rates is that the dollar will rally hard, making the U.S. less competitive.  Then you’ll need foreign exposure to benefit, but a sluggish U.S. economy is never great for the world either, so moving assets abroad is not a “no brainer.” 

Since we cannot know what the Fed will actually do, we want to follow the chart here for guidance and what I see on the chart (link above) today is the SP500 in the middle of an oscillation.  It really can go either way from this point, but my bias is that we can move up here if the Fed either does not raise rates (most positive at least for the short term) or even if they raise 0.25%. 

I think the band-aid analogy is apt here.  Rip it off fast and it does not hurt.  If they DO NOT raise rates next week, they are left with the market angst until the next meeting and the next… It may ironically feel like a relief if they raise 0.25%, and say they’ll error on the side of raising slowly. 

If they raise 0.50% in one move, Dr. Yellen would have to reassure the markets in her press conference that it was a “one and done affair.”  The Fed does not like to rope itself in, so I do not feel a rate increase of 0.50% is likely. 

I believe the market will do best if there is no rate hike on Sept. 17th, but it will still rally on a 0.25% move if Dr. Y provides the above assurance.  That’s why I’m back up to 89% [93% as of 9-11-2015] of my usual maximum equity exposure worldwide (see more details at the Twitter link below).  I am not more invested, because of the lack of a good sentiment bottom as the numbers the past few weeks show, and because the Fed could be stupid and not provide any reassurance to speak of and also because…

…if the Fed raises rates by 0.50% with no real reassurance that it is a “one and done move,” the market will sell off very hard and likely hit the 1821 support in a day or two.  That is the risk and the reason for holding back some cash.

Last week’s post follows (it’s important to read it to understand the risk to the downside!)…

We use sentiment as just one check on our fundamental and technical views of the market, and generally, we are looking for extremes.  This week the Bull – Bear % Spread of the AAII.com Survey was only +0.7%, up from -5.8% after being stuck very close to there for the entire month of August!  The nearest significant low for comparison is the October 2014 low, at which point sentiment was actually a +9.0%.   Not very negative at all.  This range of sentiment spread is neither Bullish nor Bearish, and the number of neutrals is not helpful either unless it’s extremely high (then it’s Bullish for the following 6 month period; the sentiment numbers are a prediction of where the market will be in 6 months).

Does the sentiment spread make sense, considering the recent market volatility?  Not at all, and that is the cautionary note I would take from it.  It means that investors did not “learn their lesson,” from the wild market gyrations.  They still believe all is well in the economy, despite an overly strong U.S. dollar with falling corporate profits.  GDP for Q3 and Q4 will likely fall short of current consensus expectations in my opinion and that will be the surprise that the stock market will have to adjust to, despite the current complacency of investors.

Why must the volatility from the past give rise to further volatility?
It’s like a spring that has been stretched and then let go.  What happens?  The swings in the spring continue, though the oscillations become less severe (volatility swings are less severe, but price swings can strangely be worse).

In the same way as in the summer of 2011, we hit a massive volatility peak on 8-24-2015 of 53.29 for the VIX which measures the SP500’s volatility.  Then just as in 2011, the next peak of volatility this time around was lower.  But what happened to price?  The SP500 Index retested fairly close to the lows, about 2% above the higher lows set after the 8-24-2015 panic Flash Crash bottom which was a distortion in part due to a flash crash scenario just like the one in May 2010.  After that Flash Crash, we made new lows, and we have that potential here too, particularly with a weak economy into a possible Fed tightening of short term interest rates.

After panic selling the market has an opportunity to see just how bad the losses could be a second or third time around.  Then the market dives again to at least retest the prior low if not break that low as happened after the Flash Crash of May 6, 2010.  I call that process plumbing the lows.

Be very cautious about owning stocks that had massive falls during the 8-24 Flash Crash, because they could do worse than the overall market.  They have revealed a weakness and may revisit the same level of weakness.  Some were too extreme valuation-wise and there is no way they’ll get there, but others were not so severe and those lows can be retested.  Some will break on those retests.

This should give longer term investors very good opportunities in the coming months to get better prices on stocks, but you’ll need to be patient.  These things take time.  Healing of the gyrating stock market will take time, possibly 2-3 months from 8-20-2015 when the sell-off began.  It could take less time IF the Federal Reserve surprises the market by not raising rates in September.  If they DO raise rates into a slowing economy in September, the stock market sell-off will likely hit 1821 or lower before this ends.

Given the above analysis, I set a tight stop which just went off for a portion of my latest SP500 Index buy.  See Twitter or StockTwits for more….

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