Wednesday, February 5, 2014

A stock market in desperate need of decline

Just how bullish were investors before the decline began?  According to Bloomberg Businessweek, advisers surveyed by the National Association of Active Investment Managers had 98.3 percent of their clients’ portfolios allocated to stocks in January before the decline began.  By comparison, exposure to equities averaged 72 percent during 2013.  It’s easy to see from this near-unanimity of belief in equities why the correction was bound to occur.

As discussed in Friday’s [Jan. 31] report, the latest investor sentiment reading according to AAII was evenly split between bulls and bears.  There hasn’t been a decisively negative bull-bear ration since Aug. 21, so we’re definitely overdue one now.  My guess is that this week’s AAII poll will show a plurality of bears and will show some measure of capitulation, allowing the market to bottom out at least on a short-term basis.

The following graph depicts the AAII bull-bear ratio going back to 2012.  The line should ideally plunge well below the “zero” point and fall deeply into negative territory to let us know that investors have thrown in the towel.  From a contrarian standpoint this normally marks a bottoming out point for the market.

[Excerpted from the Feb. 3 issue of MomentumStrategies Report.]