12-year study of investors sentiment points to a top

Real Clear Market

The latest investor sentiment numbers point to a uniue situation which hasn’t occured since 2005

The latest American Association of Individual Investors (AAII) sentiment survey numbers were released yesterday, and amazingly, were virtually unchanged from the week prior. For the second week in a row, bearish investors remain at 17%, still near decade-long lows. This struck me as a rare situation, so I decided to investigate further.

I set out to uncover how the market reacted when there were two or more consecutive weeks of bearish investor percentages this low, using bears below 19% as the control figure (thus allowing for roughly 20% standard deviation in the data figures). After combing through 562 weeks of AAII data by hand, I discovered that since the 2000 market peak, there have only been 12 other occurrences of this scenario. Interestingly, the current back-to-back reading of less than 19% bearish is the first occurrence we’ve seen in almost six years.  So indeed, this is a rare set up.

After locking down the dates of prior occurrences, I went on to chart each example on the S&P 500 (SPY), in order to visually coordinate how the market responded to the excessively low bearish numbers. What I found was that two or more consecutive weeks were always associated with some kind of peak in the market, even during bull markets.  In bull markets, the peak was sometimes minor, but it was still a peak.

There is another very interesting finding in my study. Without exception, when bearish investors disappeared during bear markets, it was due to a technical breakout on the indices. In other words, the shift in sentiment was due to market technicals, and not due to an improvement in the fundamental backdrop. Conversely, this was not the case in bull markets, where the sentiment shifts didn’t seem to correlate to any particular technical levels. This has important connotations regarding the market’s position now.

It seems we may be facing a similar situation today, as the market staged a technical breakout in December, yet the fundamental backdrop seems to have improved very little.

As I present the charts, the question investors need to answer for themselves is whether they believe the current market is a bull market or a bear market, because the implications of this data are quite different for each type of market. If one believes this is a bull market, then these numbers correspond to a coming correction, which may be minor. If one believes this is a bear market, these numbers correspond to a major top.

I personally believe this is the start of a major bear market, and that this sentiment data is part of the « calm before the storm. » I am, of course, always open to the market proving me wrong at some point — there’s no bull side or bear side, only the right side. But at the moment, I see far more evidence for a bear market top than for an ongoing bull market.

The first chart I’m presenting shows what happens when sentiment reaches these levels during a bear market (hint: not pretty), as last occurred five times during the 2000-2002 bear.


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Note how in every single instance, the sentiment numbers shifted in response to a technical market breakout, just as they have today. One thing bears may want to keep in mind is that during bear markets, these extreme sentiment readings sometimes went on for a third week — which can only happen if the market isn’t falling too much. Historically, that would suggest the current consolidation/rally could continue for another week. My current expectation is that it will not, however that could always change with new price action and data from the market.

The next chart shows how this sentiment corresponds with bull market peaks from 2003-2005. Again, two consecutive weeks of bears below 19% hasn’t occurred since. Worth noting is that the very first shift in sentiment for the last bull market did correspond to a technical breakout above resistance (as has occurred now) — however, it also corresponded to the 50 day moving average crossing up through the 200 day (known as the « golden cross »). So there were actually two strong technical signals to shift sentiment in 2003. This golden cross technical signal has not occurred in the SPX today, so current sentiment seems to be « jumping the gun » as it did in 2000-2002 with each upside trendline break.


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The next chart is the daily chart of the SPX. Under Elliott Wave Theory, this bear market should unfold in five waves. It appears the market is in the process of completing the second wave up, which should be followed by a very strong move down in the third wave. My expectation for the next wave is that it will first carry the SPX below the October lows, and then ultimately much lower.


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We remain on the hunt for the top of Minor Wave (2), which has thus far been sitting in the target reversal zone for the entire month of January.  This is not unexpected, as tops generally take time. Second waves are particularly difficult animals, since they are able to retrace 100% of the prior move without violating any rules. This makes them difficult to invalidate, and therefore more difficult to predict. My expectation remains that the 1300-1310 zone should put the brakes on this rally.  This is not to say that the market can’t break above this zone briefly, however, I wouldn’t expect it to stay above that zone for long.

The short term wave structure remains very messy, which is another factor that adds credence to the idea that the market isn’t going to suddenly launch into a sharp rally and break overhead resistance. Strong impulse waves have certain characteristics early on which usually give away their intentions. This rally has, so far, not displayed those characteristics. Instead, it seems to have struggled higher, and burned off much of its energy in the process. It’s a bit like a marathon runner who sprinted his way to exhaustion just as he’s approaching the steepest hill in the race — which, in this case, is the overhead resistance at 1300-1310.  It sure looks like the rally doesn’t have the required energy and momentum to break through this zone right now.

My expectation in this regard has remained the same since a week ago on Wednesday. Assuming that a major top is indeed under construction, the exact penny of the top will probably only be apparent in the rear-view mirror. The market continues to keep its options open in this regard, and as I stated yesterday, my stance remains that the reversal could begin at any time, if it hasn’t already.


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The next level the bears need to take, and hold, is 1285. The critical levels for the bulls are 1300 and 1310. At this point, everything that happens in between these two levels is just noise.

In conclusion, I believe the preponderance of evidence points to a major top in formation, or complete — and we can now add strong historical sentiment data to that collection of evidence. My expectation remains that after the market finally turns, the October lows will be broken in short order. Trade safe.

This article was originally published on Pretzel Logic’s Market Charts and Analysis.

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