Investors Remain Cautious Despite Recent Rally

Individual investors are not buying this rally despite the move to three-month highs. Bulls in the latest survey by the American Association of Individual Investors dropped seven points this week. That’s another surprising decline of optimism.

Jason Goepfert reports that even though the S&P 500 moved up more than 1% on the week to a new multi-month high, the percentage of respondents who expect stocks to keep rising declined by a whopping seven percentage points, from 34% to 27%.

Stocks usually do best when investors are modestly upbeat. When investors get more cautious, stocks tend to meander or sink back. To see what the move has meant in recent history, Goepfert queried his database for times that the S&P 500 rose at least 1% to a multi-month high but the percentage of bulls declined by five percentage points or more. He restricted the screen to weeks when bulls numbered fewer than 40% of total respondents.

Turns out that this kind of environment results in positive performance going forward. The S&P 500 was higher one month later after 20 of 21 occurrences, Goepfert reports, and with an impressive average return of nearly 3%. Returns moderated somewhat after that, he says, but there were only two losses of any magnitude in any time frame.

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Now here’s a similar finding: Non-professional investors have reacted to the turmoil of the past few months by deciding that they don’t like stocks long term. A Conference Board survey shows that fewer than 29% of consumers expect stock prices to rise over the next year — the fewest since December 2012. Nearly 33% of them expect stocks to decline. In other words, more consumers expect a market drop than a rally.

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Goepfert observes that at least this month’s spread of -4% is better than last month’s spread of -11%. Since 1987, when the spread was below 0 (more consumers looking for a decline than a rally), Goepfert reports, the S&P 500 advanced at an annualized rate of +11.2% versus a rate of +8.2% when the spread was above 0. When the spread was between -10 and 0, where it is now, the S&P 500 advanced at a rate of +14.7%.

The current market has many skeptics.

In summary, the study suggests that the market has many skeptics right now and that they won’t become bullish without some prolonged activity that takes the market higher. Not what I expected a month ago, but the data is persuasive.

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By closing over the 2,044 level on March 31, the S&P 500 reversed a 10% quarterly drawdown to finish the quarter in positive territory.

Independent market data analyst Rennie Yang observes that is a remarkable feat when you consider that over the past 30 10% quarterly drawdowns since 1950, not one led to a positive finish for the quarter. 

Yang moreover notes that the quarter finished with a gain of 5%. His research shows that over the 30 occurrences stretching back to 1998, 25 (or 83%) led to a higher S&P 500 one week later, a significant edge over the 55% random odds. The average gain was 1.7%.

Best wishes,

Jon Markman