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Minyan Mailbag: The Drop-off in Bullish Sentiment


Bulls have dropped off, but the market hasn't. That's not automatically a good thing.


Jason, what do you make of the drop-off in sentiment? Bulls are now about as low as the other market lows from the past couple of years…time to buy? Minyan Jon

By "sentiment," I'm assuming you're asking about the Investor's Intelligence (II) sentiment survey, which showed another drop in bullish opinion. Indeed, the mix of bulls and bears now is equivalent to where it was at previous market lows in the past few years.
There's just one problem…the market has not declined. The previous drops in bullish sentiment occurred while the S&P was undergoing a correction of at least a few percentage points. This time, the index has actually risen during the decline in sentiment. When something happens that is so out of the ordinary, I get a little nervous about using the traditional interpretations.
One could argue that this is the "wall of worry" we hear so much about, which is ostensibly a market-friendly phenomenon. But as Kevin and Scott point out frequently, unless investors are willing to take on risk, it causes trouble. What we're seeing now among these investors (well, a small sample of newsletter writers, anyway) is that despite higher market prices, risk tolerance is actually decreasing. That's the counter-argument to the wall of worry theory.
But instead of theory, let's look at some precedents. The most recent occurrence where we saw a steep drop-off in bulls despite a market rally was in…gulp…August 2000.

Despite a 5% jump in the S&P, we saw the bulls in the II survey decline about 10%. What we likely saw at that point was a bunch of folks pointing to the survey and saying "Hey, look, bulls are dropping off, nobody believes this rally, let's buy!" The rally carried a bit further, then, well, you know.
Historically, coming from such a high level of bullish opinion as we've had, I can find 10 other instances since 1969 of similar behavior. Performance going forward was mixed – sometimes it marked an exact low and great buying opportunity (temporarily), and sometimes it marked an exact market peak.
But there was one consistency – any gains made in the next several weeks or couple of months after this type of behavior were given back within six months or so. Every time. The market did go on to enjoy some great gains a couple of times, but one had to be relatively nimble, as those gains went "pfft" within half a year.
So the most recent drop is likely going to get a whole bunch of folks excited about this wall of worry thing. It's not far-fetched to believe that it will even be enough of a catalyst to get some traders to buy, anticipating an explosive rally. I don't discount that possibility, but I do believe that if we see such a thing, we should be forward-looking in taking profits off the table, because they will be given back at some point this year.

-Prof Goepfert
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