Another Intermediate Term Red Flag From AAII Data

This morning Sentimentrader.com showed the updated AAII survey numbers and the % allocations amongst various asset classes as of Decemeber. The bearish % in the survey remains very low relative to the 1 year mean. Usually the market pauses or declines after such a reading. Often times it takes 1-3 months for the % to flip flop to the other extreme.

Also noted was a large increase in allocation to stocks and a decrease in cash holdings. This data is used in contrarian fashion (the individuals are collectively "dumb money"). The snippet below is from today's morning comment:

Individuals' allocation to the stock market rose more than 15%, one of the largest one-month increases in the 22-year history of the survey. Their current 64% allocation to stocks is at the highest level since October 2007.

Meanwhile, their allocation to Cash fell to only 18%. While we're splitting hairs here (it dropped to 19% several times), the current allocation is the lowest since August 2000.

Oct 2007 was the peak of the recent bull market. And August 2000 was just after the peak of that bull market, but right before the Dow and S&P really fell apart in 2000-2001.

There are other surveys, etc that gather data on household investment exposure which are more comprehensive, but this survey has been a good contrary indicator for many years, so it is probably instructive at this point to do the opposite of what the typical individual is doing. So that means selling/reducing stock holdings and raising cash levels.

On another note, yesterday Sentimentrader.com highlighted some data from the Rydex fund family which again is used as a contrary indication when it reaches extreme levels. It showed that the ratio of bullish Nasdaq 100 funds to bearish funds, as well as the leveraged bull/bear ratio for the Nasdaq 100 was at an 8 year high or more. Again this is an intermediate red flag and shows that this "dumb money" group is betting very heavily on tech stocks and is also quite bullish the stock market.

So while I have been saying for a couple months that I think a sharp correction will be coming in stocks (and obviously it hasn't yet), these continued red flags only add to the evidence for that. Also the S&P is only up 2% since mid-November, so it seems a bit over zealous for such increasing and extreme bullishness despite very modest gains over the last couple months.

New All Time High in AAII Bearish %

Click on Chart to Enlarge

The chart above is a screenshot from Sentimentrader.com showing the last few years of data of the bearish respondant percentage from the weekly American Association of Individual Investors survey. Notice the huge spike below the green lines on the most recent reading. The scale is inverse so the large drop on the cahrt is actually a large increase in bearish outlook. The current reading is the highest ever in the history of the survey. The next highest reading was in 1990 and occurred just a few days after the bottom of a major leg down in 1990 where the market lost about 20% in 3 months. Taken together with all the other studies showing extreme pessimism, I have to feel more confident that a tradable bottom will occur in the next few days.

This morning we are getting another huge downer which has taken us down (as I type this) to the 127.2% retracement % of the Nov-Jan rally that I have noted in previous posts as the top of what I see as the major reversal zone for this bottom. From the looks of the charts, it seems that a move down to the lower end of the 660-690 zone (or a little further) may occur pretty quickly from this point.


Pete