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When Bears Go Missing On Wall Street: Lessons From Past Euphoria

|Includes: ProShares UltraPro Short S&P 500 ETF (SPXU), SPY, UPRO

Stock market bears are thin on the ground right now.

Fewer than 15% of US investment newsletter writers were classified as "bearish" in the latest two Investors Intelligence Advisors Sentiment report.

Such a dearth of bears is a rare event. The reading has been below 15% in only 6.2% of reports since the survey began in 1963.

The last time there were as few bears was at the beginning of 1987, an exuberant phase that ended catastrophically later that year.

A glance back across history shows there was also a scarcity of bears in early 1973, just before the S&P 500 halved, as well ahead of the bear markets of 1966 and 1976.

So, is the latest II survey readings evidence of late-stage bull-market euphoria that ought to make us wary?

First, it is worth pointing out that II bearish sentiment has not been a useful market-timing tool. (Nor does it pretend to be one.)

Initial readings of below 15% have tended to happen a long time before any top in the market has occurred.

Had an investor taken the low bearish readings in 1963, 1971 or 1983 as a sign of irrational exuberance and got out of the market, he would have missed out on massive gains.

The soonest ever top after a first extremely low bearish reading was in 1976, where the market still took more than nine months to peak out.

So, are we today more likely in the early to middle stages of a bull market - as in 1963, 1971 or 1983 - or in the latter euphoric stages - as in 1966, 1972/3, or 1987?

After almost five years of upside in the S&P - with gains of more than 172% - it's a stretch to argue we are merely at the outset of a multi-year bull market.

Fundamentals - trailing 1yr PE and the 10yr cyclically-adjusted PE ratios - as well as long-term momentum - the monthly RSI - both point to this.

<15% reading Months to top RSI monthly Shiller PE 1yr PE
Jan-1963 37 53.7 18.6 17.1
Jul-1963 31 60.3 20.4 18.3
Jul-1964 19 74.2 22.3 18.5
Jan-1965 13 73.9 22.8 18.5
Oct-1965 4 68.9 23.4 17.9
Apr-1966 -2 60.0 22.6 16.6
Mar-1971 22 57.7 17.0 18.7
Sep-1971 16 56.7 16.5 18.0
Dec-1972 1 70.5 18.3 18.2
Jan-1976 9 51.7 10.3 11.1
Jul-1976 3 61.7 11.5 11.0
Mar-1977 -6 52.6 11.0 10.1
Feb-1983 54 67.9 8.8 11.5
Nov-1983 46 68.9 10.0 12.4
Feb-1985 30 69.4 10.0 10.4
Mar-1986 18 81.1 12.4 15.1
Jan-1987 7 63.0 14.1 17.2
Nov-2013 ??? 76.0 25.1 18.5

If today's low bearish reading was early-bull market euphoria, we would expect to see either low valuations and/or more moderate long-term momentum readings.

Instead, today's valuations are higher than at the 1966 top, while overboughtness is second only to March 1986.

The first appearance of ultra-low bearish readings has not done much harm to near-term returns in the past.

(%) 1 month 3 months 6 months
Median return 1.2 2.5 2.6
Loss probability 35.3 29.4 35.3
Worst loss -2.8 -4.3 -14.9

Typically, the S&P 500 has gone up on 1 month, 3 month and 6 month view following a scarcity of pessimistic newsletter readings like today's.

The odds of the market falling are only around one in three, by contrast.

And, when the market has fallen, the 1- and 3-month losses haven't been that severe.

The current high readings are indicative of late-stage euphoria although not necessarily an imminent top.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.