What Do 1987, 2003, 2009, and 2015 Have in Common?
07/23/2015 6:00 am EST
Chris Ciovacco, at Ciovacco Capital Management, takes a technical look at past periods with similar sentiment readings. However, this analysis is not about predicting what stocks will do next. The value is simply that it helps traders and investors keep open minds about all outcomes, bullish and bearish.
If you have been involved with the markets over the past thirty years, you may find the sentiment statistics described in this article as the most surprising you have ever seen. Recent investor sentiment readings have reached levels of skepticism not seen since 1987, 2003, and 2009. If you know your market history, you also know those are the three best buying opportunities over the last 30 years.
Sentiment Can Be Helpful Near Extremes
When investor sentiment reaches extreme levels, it can be a contrary indicator for the stock market. For example, the highest bullish reading in the history of the American Association Of Individual Investors (AAII) Sentiment Survey was 75% bulls before the dot-com bubble popped in 2000. To give you a reference point, the average over the life of the AAII survey is 39% bulls. Sentiment readings can also be helpful when they reach extreme levels of skepticism, which is the topic we will explore in more detail below and tie it into the present day.
This Has Happened Only Three Times Since 1995
The eight-week moving average for % bulls in the AAII Sentiment Survey recently dropped to an extremely low level in 2015, a level seen only two other times since 1995. The other two times were two of the best periods to invest in the last thirty years; early in 2003 and early in 2009.
In the chart above it is important to note we did not pick the comparison periods; the data selected the periods. The comparison is based on facts, not opinions. Since 1995, the recent reading has been seen only three times; 2003, 2009, and 2015.
Was 2003 a Good Time to Invest?
With similar skeptical sentiment to what we have seen recently in 2015, the spring of 2003 offered a great investment opportunity from a short-term perspective. As shown in the chart below, despite the stocks are going nowhere sentiment of the day, the S&P 500 (SPX) rallied from 800 to over 1100 in less than a year (a gain of over 37%).
2003: From a Longer-Term Perspective
If you would have asked the average investor in 2003:
- Is it possible for stocks to rally sharply over the next four years?
A common answer, based on the sentiment of the day, might have been "no way, not going to happen." It did happen as shown in the 2003-2007 S&P 500 SPX chart below:
NEXT PAGE: Stocks Staged a Big Rally in the Wake of Extreme Investor Skepticism|pagebreak|
Was 2009 a Good Time to Invest?
With similar skeptical sentiment to what we have seen recently in 2015, the spring of 2009 offered a great investment opportunity. In the wake of extreme investor skepticism, the S&P 500 rallied from the March 2009 intraday low of 666 to over 1200 in a little over a year.
What About Weak Market Breadth?
Regardless of what recent sentiment says from a probability perspective, you may feel it does not matter since market breadth in 2015 has been noticeably weaker. This week's video examines the questions:
- How long and how far can stocks rise with weakening market breadth?...Is it a showstopper?
Video: Market Breadth vs. the Weight of the Evidence
Easy to Understand Skepticism After 1987 Crash
For those not familiar with Black Monday, the S&P 500 dropped over 20% in one day. Therefore, it is very easy to understand investor skepticism reached extreme levels after the 1987 stock market crash. What is surprising is that 2015 investor skepticism has reached an extreme level not seen since the period following the 1987 crash. From MarketWatch:
"For the past 15 weeks, neutral sentiment in the AAII Sentiment Survey has registered above 40%, tying a record set in the wake of the Black Monday market crash of 1987. Charles Rotblut, editor of AAII Journal, has noted that unusually high readings of neutral sentiment typically coincide with better-than-average returns for the S&P 500 Index."
Similar Sentiment Post-Black Monday
If the record for weeks above 40% neutral sentiment is shared by the period following the 1987 crash and 2015, a logical question to ask is what happened next in 1987? The answer is stocks went up, not down.
1987: How About from a Longer-Term Perspective?
With extreme levels of investor skepticism, those who stepped outside of the 1987 groupthink category and remained with the stock market were handsomely rewarded. If we asked someone after the 1987 crash "what are the odds that stocks rally sharply over the next thirteen years," we may have been hit with a "have you lost your mind?" response. Despite the widespread skepticism about stocks, the S&P 500 came off the 1987 lows and rallied for the next thirteen years.
2015: No Way Stocks Can Rally
Things are awful in 2015: Apple (APPL) is down after hours, Greece is still a mess, the Fed is getting ready to raise rates, and earnings have been weakening. There is no possible way that stocks can rally, right? The market will decide, but things looked horrible after the 1987 crash, after the dot-com bust, and after the financial crisis as well. Did stocks tank in those three cases with similar sentiment to the present day? No, stocks did not follow the path that most anticipated. Instead of falling, they not only rose, but rose significantly.
NEXT PAGE: How Is This Analysis Helpful?|pagebreak|
But, 2015 Is Different from 1987, 2003, and 2009
Yes, that is true. The same comment applies to all historical analysis (bullish and bearish). This article has looked at two indisputable facts:
- The eight-week moving average for % bulls in the AAII Sentiment Survey recently dropped to an extremely low level in 2015, a level seen only two other times since 1995. The other two times were two of the best periods to invest in the last thirty years; early in 2003 and early in 2009.
- For the past 15 weeks, neutral sentiment in the AAII Sentiment Survey has registered above 40%, tying a record set in the wake of the Black Monday market crash of 1987; also one of the three best times to invest in the last thirty years.
We did not cherry pick the data. The data picked the periods; 2015, 2009, 2003, and 1987.
AAII Survey Not the Only Evidence
We have seen similar and extreme bearish sentiment readings from other sources. For example, the CNN Money Fear & Greed Index was at an extreme fear reading of 22 a week ago.
Investor's Intelligence Survey Also At An Extreme Level
Ryan Detrick points out in a July 19 article that the Investor's Intelligence Survey recently hit an extreme and rare correction percentage greater than 40%, meaning over 40% of newsletters believe a correction is coming in the stock market. Ryan Detrick's article shows S&P 500 returns have been favorable following such an extreme correction reading. From Investor's Intelligence:
We study over a hundred independent market newsletters and assess each author's current stance on the market: bullish, bearish, or correction. Since we have had just four editors since inception, there has been a consistent approach to determining each advisor's stance and his prior viewpoint.
How Is This Analysis Helpful?
From our perspective, this analysis is not about predicting what stocks will do next. The value is simply that it helps us keep an open mind about all outcomes, bullish and bearish. If we have an open mind, we can put plans in place for bullish and bearish scenarios. Experience says it is dangerous to decide in advance what the market is going to do, since it often does just the opposite. For now, the primary trend in stocks remains up and the S&P 500 is stuck in the same range it has been for months. If a correction is on the way, price will not miss it. We are happy to adjust if and when needed. Given what we know today, the evidence still calls for a equity-heavy allocation.
Recency Bias May Be a Big Factor In 2015
Why are investors so skeptical today? There are many factors in play, but one of them may be recency bias. Investors "have seen this before."
Stocks rallied into the 2000 high, and then crashed. That was followed by a rally into the 2007 highs; that too, was followed by a stock market crash. From the 2009 lows, stocks have rallied and now it must be time for them to crash again, right? History and the charts say that assumption may turn out to be inaccurate. Only time will tell, but the sentiment analysis presented here tells us to keep an open mind about all outcomes.
By Chris Ciovacco at Ciovacco Capital Management