If there is a dominant theme in the stock market these past few weeks it has been the lack of commitment by investors. According to the latest sentiment survey conducted by the American Association of Individual Investors (AAII), 28% of respondents were bullish and 28% were bearish while 43% were neutral. According to Jeff Macke of Breakout.com, this is the highest level of neutrality in more than 10 years.
Moreover, investors have been essentially neutral for the past 13 weeks according to the AAII poll. You’d have to go back to 2012 to see a similar stretch of neutral readings.
Unfortunately, prolonged neutral sentiment has no forecasting value. And contrary to what the pundits are saying, an extended period of investor neutrality doesn’t guarantee that a decisive breakout, or breakdown, is imminent. All that the neutral sentiment backdrop tells us is that investors have been driven to the point of indecision by the lack of directional movement in the stock market.
There is an old Wall Street saying, however, that goes something along the lines of “Never sell short a dull market” in a bull market. That is, if investors lose interest and volume and volatility shrink while the major uptrends remain intact, it’s probably a safe assumption that the path of least resistance still remains up. In other words, it’s not usually safe to bet against a trading range market while the bull market persists. Only when the key trend lines have been broken to the downside are we safe in assuming that the bears have taken control of the market.
[Excerpted from the 5/9/14 issue of Momentum Strategies Report]