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Summary

  • Individual Investors are over 50% bullish.
  • Less than 20% are bearish.
  • Average Stock Market Returns have historically been negative 3-6 weeks out.

Last week the spread, between bullish individual investors and bearish individual investors, reached above 32.6% for the 131st time in its history, since data became available in July of 1987. The percentage of bullish individual investors was 51.92% and the percentage of bearish individual investors was 19.23%. This data is updated weekly by the individual investors alliance ( profile here on Seeking Alpha) for individual investor's 6 month outlook.

The spread of bullish to bearish investors, before this week, has only been above 32.6% for only 9.2% of the time since data collection began. Now, what has this historically meant for nominal returns of the SP-500 (NYSEARCA:SPY)?

Return Time Frame

Week 1

Week 2

Week 3

Week 4

Week 5

Week 6

Average Return

0.06%

0.28%

-0.09%

-0.17%

-0.14%

-0.18%

Standard Deviation

1.87%

2.49%

3.04%

3.45%

4.28%

4.65%

Max Return

4.85%

9.07%

7.16%

8.34%

6.95%

8.56%

Min Return

-5.80%

-7.44%

-11.87%

-10.77%

-23.78%

-22.35%

One sees that on average, although lacking statistical significance, there is not much of an upside edge, also the weekly returns are calculated from Wednesday to Wednesday instead of Friday to Friday because the weekly survey finishes on Wednesday. After week two there is a bias down. Also, notice if there is an up-move, as shown by the maximum return, it does not follow through after week 2. Week 6's max return is 8.56% while week 2's is 9.07%. Traders/Investors also need to be aware of the large skewness between the maximum and minimum returns. The largest drawdown is over 2.5 times the largest run-up.

I will point out that the largest drop for Week 1 did not follow through to larger losses. Just because, on average, losses get larger from the initial data point, it does not mean the market has to continue to drop. That said, the data seems to indicate a potential for much larger down moves than up moves. As the old saying goes, "If everyone is bullish, who is left to buy?"

How about looking at data where bullish investors are at 51.92% or above? This has happened 10.97% of the time before last week, and the results:

Return Time Frame

Week 1

Week 2

Week 3

Week 4

Week 5

Week 6

Average Return

0.04%

0.14%

-0.21%

-0.33%

-0.29%

-0.35%

Standard Deviation

1.93%

2.50%

3.14%

4.05%

4.63%

4.95%

Max Return

4.85%

9.07%

7.16%

8.68%

7.39%

9.09%

Min Return

-5.80%

-7.44%

-12.44%

-25.45%

-24.02%

-24.57%

Traders/Investors see very little upside on average, with negative returns occurring on average after 3-6 weeks (still not statistically significant). Again, there is skew to the downside if a larger move happens to occur; to be clear this is not projecting a correction or crash, however, it does show "fat tails" in the distribution. Plan your risk management accordingly.

The number of bears is also low at 19.23%. Here is what the data looks like when it is at this level or lower - about 12% of the time:

Return Time Frame

Week 1

Week 2

Week 3

Week 4

Week 5

Week 6

Average Return

-0.03%

0.06%

-0.03%

0.01%

0.03%

-0.10%

Standard Deviation

1.98%

3.20%

3.46%

4.04%

4.67%

5.19%

Max Return

4.85%

9.07%

9.39%

11.26%

13.10%

12.72%

Min Return

-9.56%

-22.57%

-21.14%

-21.69%

-23.78%

-25.11%

First, the average return is very close to zero for all time frames. I also noticed large gains are still possible in the future. Finally, a large drop can occur much more quickly than in the previous data. Week 1's largest drawdown was almost 10%, and Week 2's was about 3X greater, than the previous data, at -22.57%.

I believe the reason for some of the differences in the results is that this survey has three possibilities. An individual investor can be bullish, neutral or bearish; hence, the need to study the levels of bulls, bears, and also the spread between the two.

We even find statistically significant results (assuming normality) at the 5% level, as shown in the following cross-correlogram graph, between the weekly returns of the SP500 and the spread between the bulls and bears.

One sees that the level of the spread, between bullish and bearish investors, does have a slight, but significant effect, 3 or 4 weeks later. Three weeks ago the spread was -7.3% and since then the market has returned over 4% (Four weeks ago the spread was at zero). This data also shows that the optimism or pessimism follows current or lagging returns even more strongly.

The graph of the spread, between bulls and bears, appears to be mean reverting, and an econometric regression showed the mean level to be about 8.4%.(click to enlarge)

And here is the Spread and SP-500 weekly returns ( ld_SPClose: on left scale) shown together:

(click to enlarge)

In the last 6 years large returns have followed levels of extreme pessimism which is in contrast to a very optimistic outlook currently. If you have a bullish bias, be aware that there are not many buyers left according to this data, and this interpretation. Wait for a pullback in sentiment for your tactical trading decisions. If you have a bearish bias you might have just thrown in the towel to soon, so don't be afraid to take another position into the historically weak month of September; just remember to cover or turn bullish when sentiment hits the other extreme.

Source: Individual Investors' Bullish Sentiment