One of the biggest problems for the stock market entering 2014 was the near unanimous belief on Wall Street that stock prices would only go higher this year. Indeed, you had to look a long way to find even a hint of bearishness at the start of the year.
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.
Even as recently as Jan. 30, investor sentiment according to AAII was evenly split between bulls and bears. Until this week there had not been a decisively negative bull-bear ration since Aug. 21, which underscores how relentlessly bullish the typical investor was. Recent sentiment readings are closer in line with what a short-term market low should look like, however, as finally many of those bulls have thrown in the towel.
From an intermediate-term standpoint, however, there are still a few too many bulls. 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 completely thrown in the towel. From a contrarian standpoint this normally marks a solid intermediate-term turning point for the market.