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Optimism among individual investors is near a three-year high according to the latest AAII Sentiment Survey. Pessimism, meanwhile, is near a two-year low.

Bullish sentiment, expectations that stock prices will rise over the next six months, jumped 7.6 percentage points to 55.1%. This is the highest level of optimism recorded by our survey since January 6, 2011. It is also the 10th time in the past 12 weeks and the 12th in the last 16 weeks that bullish sentiment is above 40%. The historical average is 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged, declined 1.1 percentage points to 26.4%. The drop puts neutral sentiment at a four-week low. This is the also the fourth time in the past five weeks that neutral sentiment is below its historical average of 30.5%.

Bearish sentiment, expectations that stock prices will fall over the next six months, plunged 6.5 percentage points to 18.5%. This is the 11th consecutive week and the 13th out of the past 15 weeks with a bearish sentiment reading below the historical average of 30.5%.

This week's results puts bullish sentiment at an unusually high level and bearish sentiment at an unusually low level (more than one standard deviation above and below the respective historical averages). Though this could be interpreted as a warning sign that individual investors' short-term expectations are too optimistic, the data is inconclusive. When bullish sentiment has previously been at unusually high levels (between 49.3% and 59.7%), the S&P 500 has risen by a median of 2.9%. When bearish sentiment has previously been at unusually low levels (between 10.6% and 20.5%), the S&P 500 has risen by 4.5%. In comparison, the S&P 500 has realized a median 4.7% gain for all six-month periods since the AAII Sentiment Survey was started in 1987. (See Is the AAII Sentiment Survey a Contrarian Indicator for more information.)

Many individual investors continue to be encouraged by the new record highs established by the large-cap indexes along with earnings growth and economic growth. The two-year budget agreement has also alleviated worries about another partial government shutdown occurring next year. Keeping optimism from being even higher are concerns about the pace of economic growth, elevated stock valuations and the lack of a long-term fiscal solution.

This week's special question asked AAII members whether they agreed or disagreed with the Federal Reserve's decision to taper its bond purchases. Respondents overwhelmingly said they agree with the decision. Several members added that the Fed should have started reducing its monetary stimulus sooner or that a more aggressive move should have been announced. Some members said they thought the taper is good in that it starts to remove the unusually high level of monetary stimulus from the market, while others clarified that they are in agreement with the Fed's move as long as the tapering is gradual. A few respondents dissented, saying a larger removal of stimulus was warranted or that quantitative easing should have never been started in the first place.

Here is a sampling of responses:

  • "Agree. It is time for the Fed to let the market heal itself."
  • "I agree. As long as the taper is gradual, it will be good for the economy and the markets."
  • "Yes, I agree, but the Fed should have increased the taper by a larger amount."
  • "Agree. It's long overdue."
  • "The Fed should have never done it in the first place."

This week's AAII Sentiment Survey results:

  • Bullish: 55.1%, up 7.6 percentage points
  • Neutral: 26.4%, down 1.1 percentage points
  • Bearish: 18.5%, down 6.5 percentage points

Historical averages:

  • Bullish: 39.0%
  • Neutral: 30.5%
  • Bearish: 30.5%

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 here.

Source: AAII Sentiment Survey: Optimism Near A 3-Year High