Bulls Add To Their Herds

6/9/2014


While stocks entered the year riding a wave of momentum, they've been weighed down by concerns that they may have come too far, too fast. For all the hand-wringing, stocks in the S&P 500 Index have averaged 6% total returns in 2014, led by the defensive utility and health-care sectors.

Encouragingly, participation in the upswing remains fairly broad, with two-thirds of S&P 500 stocks posting positive returns for the year. Small stocks sing a more somber tune, with members of the S&P SmallCap 600 Index averaging a loss of 4% this year; just 37% have generated positive returns.

Fund flows for both equity mutual funds and exchange-traded funds have been consistently positive this year, combining for an average weekly inflow of $4.01 billion through late May, compared to an average of $6.57 billion for full-year 2013. At the same time, volatility is low and trading volumes languid. One widely followed gauge of fear in the stock market, the Chicago Board Options Exchange Volatility Index (VIX), slipped to a 14-month lowin late May.

Sentiment trends have split sharply, with just 36.5% of individual investors in the most recent (May 29) American Association of Individual Investors Survey. In contrast, there is no shortage of optimism among newsletter editors, where the percentage of bulls climbed to 58.3% in late May, then 62.2% in June, according to Investors Intelligence. That marks the highest reading since December 2004. Just two weeks since 1990 have seen a greater proportion of bullish newsletter editors.

John Gray, author of Investors Intelligence, says bullish readings above 60% are dangerous territory. During 12-month periods after weeks with bullish sentiment that high, the S&P 500 Index averaged returns more than seven percentage points below the long-run average, with 24% of periods suffering losses of more than 10%. Admittedly, with only 21 weeks of similarly high sentiment, the sample size is small.

On the opposite end of the spectrum, 17% of editors are currently bearish — 41 points lower than the bullish percentage. Gray notes that investors should be wary when bull-to-bear spread exceeds 40 percentage points; this last happened during a nine-week stretch that ended Jan. 21, 2014.

More individual investors are adopting a bullish stance, with 37% viewing themselves as bulls, compared to 30% a month ago. But sentiment remains tepid relative to historical norms and editors' ebullience, with 60% of weeks since 1990 registering a greater percentage of bulls. As shown in the table below, the S&P 500 has historically gone on to perform fairly well over the next 12 months with sentiment in this range.

BULLS IN CONTEXT
Using history as a guide, current sentiment levels for individual investors are more encouraging than those of newsletter editors. In rolling 12-month periods since the start of 1990, the S&P 500 Index averaged a gain of just 1.5% with adviser sentiment in the current range, versus an above-average 10.9% for the current level of individual-investor sentiment. Investors Intelligence conducts the editor survey, while the American Association of Individual Investors collects data through a survey of its members.
----- S&P 500 12-Month Returns -----
Number Of
Occurances
% Up
%
Down
% Up
More
Than 10%
% Down
More
Than 10%
Average
Return
(%)
Individual investor bullishness, 35% to 40%
No. of periods in range
247
84
16
55
10
10.9
Total no. of periods
1,220
79
21
52
15
8.9
Newsletter editor bullishness, above 60%
No. of periods in range
21
81
19
33
24
1.5
Total no. of periods
1,221
79
21
52
15
8.9

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