Pessimism in the Stock Market

Pessimism and the SPX!

Too Many Bears in the Market Place!

by Ian Harvey

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July 24, 2012

Introduction

For 25 years, the Investor Sentiment survey produced by the American Association of Individual Investors (AAII) has measured retail investors' sentiment toward domestic equities. In those 25 years, rarely has the investing public shunned equities as violently as they are doing now. A closer look at the latest release of data illustrates that only 22% of investors are bullish, while nearly 42% are bearish -- a pessimistic posture that suggests a grueling grind ahead for stocks.

However, by employing a philosophy that looks beyond the depressed state of crowd sentiment, there is a supporting theory, where an investigation of prior instances of extreme bearishness unveils an optimistic caveat you should be aware of.

Over the past 11 weeks (or nearly a quarter of a year), bearish sentiment has outweighed bullish sentiment. Going back to 1987, this is the sixth-longest streak of persistent pessimism. Let's take a quick look at previous bouts of prevailing skepticism:

• Ending on 12/28/1990, we had a streak of 22 weeks where bears outnumbered bulls.

• Ending on 8/17/2006 and then again on 3/20/2008, we had streaks lasting 14 weeks.

• Ending on 10/23/1992, we saw a streak of 13 weeks.

• Ending on 8/27/1993, we faced a streak of 12 weeks.

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Pessimism and Your Reaction!

Will this onslaught of bear pessimism create problems with your trading -- or will you take the philosophical view that this streak must end and return to a bull phase? Here are statistics showing how the Standard & Poor's 500 Index (SPX) has performed after similar streaks in the past.

As you can see, the SPX -- after an extended period of pessimism -- easily outperforms the "at any time" returns.

However, there is one problem with these statistics -- there aren't many instances of this dynamic occurring, therefore the results are suspect and not indicative of future returns!

This is a very real observation, bearishness is at an extreme, but do you want to be like the crowd and sell out of fear, or do you want to take the high road and sell of your own accord, on your terms? History suggests the prudent course of action is to buy when others are fearful, not euphoric.

Further Articles Relating to the Week Ahead

1. The Week Ahead in the Stock Market - July 23, 2012

2. The Economy and Earnings in the Week Ahead – July 23, 2012

3. The Past Week Stock Market Results – July 23, 2012

4. The Major ETFs in the Week Ahead – July 23, 2012

5. Indicators Offer Uplift to the Stock Market, July 23, 2012


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