Thursday, December 23, 2010

Bullish Sentiment Can Be Bullish

In a time and age where every investor sentiment indicator is used as a contraian figure, its likely that most of the analysts spewing such non-sense haven't ever reviewed whether it is factual. First, just because a sentiment figure is calculated it doesn't mean that the pollsters are actually rigorous in their answers. Its easy to say your bullish these days, but not likely as easy to have actually invested cold, hard cash. Hasn't the consumer sentiment numbers taught us over the years that spending doesn't always match sentiment. Second, being initially bullish doesn't mean that investors can't an won't remain bullish for a long time. Opinions don't seem to swing that quickly.

Ciovacco Capital did some interesting work on investor sentiment and found out that it's not as indicative of a pending market crash as the procrastinators on TV would suggest. They worked with Robert Colby, author of The Encyclopedia of Technical Market Analysis, to better understand what bullish sentiment typically predicts. Per Mr. Colby:


On advisory service sentiment, there were 56.8% bulls versus 20.5% bears as of 12/15/10, according to the weekly Investors Intelligence survey of stock market newsletter advisors. The Bull/Bear ratio stands at 2.77, which is between one and two standard deviations above the long-term, 20-year mean. This is not overly excessive bullish sentiment in the second year of a bull market. Bullish sentiment tends to rise in November and December. The ratio was as high as it is now or higher in Decembers of each year 2003, 2004, 2005, and 2006, and none of these “high” readings led to bear markets. The 20-year range is 0.41 to 3.74, the median is 1.54, and the mean is 1.61. 
The VIX Fear Index fell below 8-month lows to 15.46 on 12/17/10, reflecting diminishing fear among options players. VIX is near its 3-year low of 15.23 set on 4/12/10. Before we take the current level of VIX as a sell signal, however, we might consider that VIX was as low as 9.89 on 1/24/07, nearly 10 months before the final tops in the price indexes. VIX is a market estimate of expected constant 30-day volatility, calculated by weighting S&P 500 Index CBOE option bid/ask quotes spanning a wide range of strike prices for the two nearest expiration dates.

So everybody is trying to spend the bullish sentiment as bearish, but clearly this is a cyclical number that had no impact on the bull market of the 2000s.  Its also interesting to note that the low VIX wasn't the actual sell signal, but the signal to prepare to sell.

Further, Ciovacco Capital was able to determine that such a bullish ratio led to 100% positive markets over the next 6 months when observed in the 2000s. Even better, the 2003 market which is probably most indicative of the current climate saw a 10.66% gain in the next 6 months.

Check out the data for yourself and ignore the bearish spin on the bullish sentiment. It does nothing to signal anything a top in sight.

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