Caution: Both the Smart Money and the Dumb Money are Bullish on Stocks

Another indication of rough seas ahead

Bullishness among retail investors jumped to its highest level in seven years, and bearishness dropped to its lowest level in three years, according to the latest American Association of Individual Investors sentiment survey.

Bullish sentiment rose to 59.8%. The last peak in bullishness was 63.3% on December 23, 2010. The 30-year average reading of bullishness is 38.5%.

Bearish sentiment fell to just 15.6%. The last bottom for bearishness was 15.1% on November 6, 2014. The 30-year average reading for bearishness is 30.5%.

Pop Quiz: 

What happens when too many passengers crowd onto one side of the boat? Answer: they face a choice. Stay put and risk drowning as the boat capsizes, or move towards the other side and save yourself.

Of the 1,560 weeks since the AAII survey began there have only been 46 (2.9%) with a similarly bullish reading. What happened to the S&P 500 index over the following 6 months after these extremes in bullishness? The median change was a negligible gain of 0.5%.

It's too early to abandon ship

Astute investors will take this extreme sentiment reading as an early-warning signal, rather than a "sky is falling" one. It might be a good idea to cut back a little on your equity exposure, but not a lot. Pay attention to other warning signs, like a 5% drawdown from the most recent high-water mark in the market. Or a string of 3 or 4 "lower lows" in a row.

Instead of jumping ship, just put on your life vest and find out where the lifeboats are.

About the Author

Former head of equity trading, Northern Trust Bank, Chicago. Teacher, trainer, mentor, market historian, and perpetual student of all things related to the stock market and excellence in investing.

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