Bullish Sentiment Survey

NOTE:  This Market Commentary alert was originally emailed to subscribers at Ritholtz Research & Analytics on Mon 1/22/2007 11:05 AM;

This is posted here not as investing advice, but
rather as an example of a trading call for potential subscribers. We
expect to post future advisories in a similar manner — after the call,
but in the correct chronological location on the blog.

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American Association of Individual Investors (AAII) – Bullish Sentiment Survey

Aaii_inv_sent

Sentiment may be the key factor in terms of making the determination when this market may be tired and ready to significantly correct. Anecdotally, we have spoken to numerous individual and institutional clients recently about how long bull markets tend to build high levels of over-confidence; Those high levels of over-confidence are frequently accompanied by over-investment.

What sentiment surveys highlight is the level of investor commitment to the markets. Why? Surveys have shown that people become Bullish after they put their money to work. When sentiment is bullish or excessively bullish it suggests investors are at or near full investment. When that happens, there is little fuel left to power the markets substantially higher. 

This report includes two of the indicators in our master sentiment model: 1) The American Association of Individual Investors (AAII) Bullish Sentiment Survey (above); and 2) the American Association of Individual Investors (AAII) Asset Allocation Survey (below). Each shows that investor confidence and asset allocations towards equities are at bullish (optimistic) levels. Although these levels are not at extremes yet, they need to be watched, as bullish and overly bullish levels suggest investor buying power is diminishing.

Since they act in a contrarian manner these bullish levels are typically symptomatic with future corrective activity. 

A note of caution: Sentiment is never known for being a very timely indicator so it obviously needs to be confirmed by other metrics such as; price weakness, aggressive downside price and volume action as well as breaches of key support levels.  We continue to watch $42.00 on the Q’s, which we recently highlighted on Nasdaq Comp Review (January 17 2007) as an area of key support.)

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5 Week Moving Average American Association of Individual Investors (AAII)
Asset Allocation Survey

Aaii_asset_alloc

Note that the Asset Allocation Survey, while not terribly over-allocated to US Equities, is nears the high end of its range.  Compare those levels with what equity allocations looked like at highs in 1998 and 2000, and again at lows in after 1987, 1990, and 2003.

We use a moving average to eliminate the short term noise and volatility associated with surveys of this sort. While the actual measure of asset allocation has pushed into the over-allocated zone, it would need to stay high for a few weeks to bring up the moving average into the danger zone.

We will be watching this crucial sentiment indicator closely over the coming weeks. . .

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