Sentiment Worsens As Stocks Rise

 

With many stocks meandering higher, we're not seeing a lot of enthusiasm among most of our sentiment indicators.  Some of them, like the Investor's Intelligence survey, are showing more and more folks moving to the sidelines even with a steady market.  The neutral responses in that survey are nearing the highest levels of the past decade.

 

We can see that too in the Intermediate-term Indicator Score.  The S&P is close to a 52-week high, but the Score is near the lower end of its range and moving lower even as stocks move higher.  This means that our indicators are showing less bullishness (Chart 1).

 

I've argued repeatedly over the years that the theory that stocks "climb a wall of worry" is wrong-headed.  They don't do that.  Stocks rise when investors become more and more bullish, not less and less so.  Declining optimism is a bad thing for stocks, until it gets to a point where it is at an extreme level and we can reasonably expect stocks to counter-react based on historical norms.

 

Let's go back to 2000 and look for any other time the S&P had climbed to within 1% of a 52-week high, yet the Indicator Score was at a level of 1.1 or worse (Table 1).

 

We can see from the previous instances, that this wasn't a great sign for stocks.  The mediocre-to-poor sentiment readings led to a positive market over the next 2 months only 1 time out of 11 attempts (several of them were clustered together).

 

The worst period was during the next 30-50 days.  Before and after that, stocks were moderately weak, but not overwhelmingly so like during that window.

 

During the next two months, the S&P's average drawdown (maximum loss at its worst point) was -6.0%, with all but one losing at least -3.3%.  Its maximum gain averaged only +1.7%, and only one was larger than +2.5%.

 

The curious thing about this is that the market's performance was much better if the S&P was more than 1% below its 52-week high - in other words, if the market was correcting as sentiment was worsening.

 

To be honest, I'm not sure how much weight to put on this.  It has obviously been consistently negative and consistency is important, but it conflicts somewhat with a study we looked at last week (though that was longer-term in focus).  If the S&P 500 drops below 1390 it'll be more alarming and below 1350 it'll be a big red flag.  At least until the Score drops to 1.30 or more.