Retreat in Bullish Sentiment Paves the Way to Higher Ground

by Chris Johnson | March 19, 2012 7:00 am

[1]For many investors, the idea of buying into the recent rally is a scary one. The market might feel toppy, unless you have an indicator that suggests it is more likely we will see another round of buyers enter the fray. Enter the weekly Investor’s Intelligence poll.

The current market environment is one where an indicator such as the Investor’s Intelligence poll can become a handy tool for investors. In a nutshell, the poll tracks the sentiment (outlook) of a number of newsletter editors by gauging whether they are bullish or bearish, or whether they think the market may hit a short-term correction.

As with many sentiment indicators, the data has become a well-known tool in determining the beginning and end of a rally by defining when the “crowd” may have become too bullish or bearish. While this indicator gains the most attention when the market is at the extreme ends of a trend, the weekly changes in the data can offer a great indication as to whether a rally is set to continue or fade. This brings us to the latest activity in the Investor’s Intelligence poll, which suggests the market is likely to continue its trek higher.

This week’s poll results showed a drop in the bulls to 43.6%. This reading is 20% lower than the reading a month ago, when the bulls topped-out at 54.8%. What is interesting about this is that the bulls have pulled back, despite the fact that the S&P 500 has climbed 2% higher during the same period.

We tested the historical data for 2% increases in the S&P 500 Index when the bulls dropped by 10% or more. There are only five other instances where this rather disparate signal was met.

Overall, the SPX post-signal results were bullish, with some mixed results immediately following. After a month’s trading, all but one instance resulted in strong (better than two-times average returns) performance, with an average one-month return of 2.7%.

The fact that the Investor’s Intelligence bullish percentage has dropped while the market has rallied can be classified as another sign that stocks are indeed climbing the Wall of Worry, likely to produce some significantly strong gains in the S&P 500 over the next month.

Investor's Intelligence Bulls and BearsClick to Enlarge

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