Bullish Sentiment Is Dangerously High

Bullish SentimentThis is an important week for the markets, as we’ve got the Fed and other important economic reports coming out.

As far as the Fed is concerned, it is highly unlikely that they will raise interest rates from the current 0.25%. The statement following the rate announcement is something to pay attention to though. There will probably be some bearish comments which would further justify their easy money policies.

I want to point out how crazy bullish investors are getting right now. There is a survey done by the AAII which measures how bullish or bearish investors are and is conducted on a monthly basis.

The AAII sentiment index is reaching highs seen in three previous market crashes. This is bad news, especially when coupled with bearish technicals. When this sentiment indicator gets this overheated, the markets tend to peak. Just looking at the below chart, we can see that huge drops followed the peaks in bullish sentiment.

AAII Investors Sentiment Survey

AAII Sentiment IndexAAII Sentiment % Bearish Index

I’ve seen first hand how bullish some investors are getting. Whether it’s on well trafficked blogs or on twitter, I keep getting the feeling that there are too many bulls on steroids right now for the current situation we are in from a fundamental and technical standpoint.

October 2007 was when the Dow was trading at it’s peak of 14,200 which has not been reclaimed in the three years since!
May 2008 saw the markets drop by 6,600 points!
January 2010 was when the markets stopped just short of a correction in a few short weeks!
There is no justification for this bullishness. One report or one reading does not make a trend. There have not been any consecutive economic reports showing strong and consistent growth or significant improvement. Investors have become used to “less bad” news and this can be very misleading. If markets rally because the US loses 400,000 jobs instead of losing 460,000, and investors get excited about this, then we have some serious problems coming our way.

In this situation, prudence may be your best bet. Stepping out of the bull pen out of caution sure beats running for the gates with a stampede behind you, or worse, in front of you. Pre-emptive defensive trading is far better than having to scramble to stop the bleeding.

I don’t like being a bear, but when warning signs flash like this, ignoring them would be irresponsible. We will see what happens in the next few weeks. With volume surely to return to the markets, there should be plenty of action to blab about, so stay tuned for updates.

Bullish Sentiment Is Dangerously High