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Individual investors have become cautious, as is evidenced by the largest weekly drop in optimism since November 2010.

Bullish sentiment, expectations that stock prices will rise over the next six months, plunged 13.4 percentage points to 28.4%. This was the largest one-week drop since November 18, 2010, when optimism fell from 57.6% to 40.0%. This is also the first time in eight weeks that bullish sentiment is below 40%. The historical average is 39%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, surged 9.3 percentage points to 35.0%. This is the highest neutral sentiment has been since August 16, 2012. The historical average is 30.5%.

Bearish sentiment, expectations that stock prices will fall over the next six months, rose 4.1 percentage points to 36.6%. The rise puts pessimism at its highest level since November 22, 2012. The historical average is 30.5%.

The bull-bear spread, which measures the difference between bullish and bearish sentiment, turned negative for the first time since November 22, 2012. Prior to this week's reading, more AAII members were optimistic than pessimistic about the short-term direction of stock prices for 13 consecutive weeks.

Two concerns are weighing in on individual investors' moods right now. The first is the duration of the current rally. Many individual investors think the market has gotten ahead of itself and is due for a pullback in prices. The other is the looming threat of sequestration, which AAII members think could impact stock prices over the short term.

This week's special question asked AAII members how the threat of sequestration is impacting their sentiment towards U.S. stocks. Slightly more than 40% of respondents said the threat was having little or no impact. Many think the publicity is worse than the actual fiscal standoff. Slightly more than a quarter of respondents described themselves as being more bearish or more worried about the short-term direction of stock prices because of the sequestration threat. Some members said they would view a pullback in stock prices as a buying opportunity and others said they were refraining from making purchases at this time. A few members think the current standoff could result in a solution that will be good for stocks over the long term.

Here is a sampling of the responses:

  • "There is a lot of media and pundit handwringing over sequestration. However, I think it will have a minimal impact on most investments."
  • "Little impact. There may be a short-term effect, but in the long run, it may be a good thing as government spending has to be reigned in."
  • "Not affecting my sentiment at this time, as I expect any bearish movement to be short term in nature."
  • "It makes me very cautious."
  • "It will hurt in the short run, but will have a positive effect three months out or more. This is because the market will react positively to the U.S. finally doing something about its debt crisis."
  • "No impact. Our government is going to make good or bad choices. I can't plan for it."

This week's Sentiment Survey results:

  • Bullish: 28.4%, down 13.4 percentage points
  • Neutral: 35.0%, up 9.3 percentage points
  • Bearish: 36.6%, up 4.1 percentage points

    Historical averages:

    • Bullish: 39.0%
    • Neutral: 30.6%
    • Bearish: 30.6%

    The AAII Sentiment Survey has been conducted weekly since July 1987 and asks AAII members whether they think stock prices will rise, remain essentially flat, or fall over the next six months. The survey period runs from Thursday (12:01 a.m.) to Wednesday (11:59 p.m.) The survey and its results are available online.

Source: AAII Sentiment Survey: Biggest Plunge In Optimism Since November 2010