When sentiment is stretched…be cautious |

When sentiment is stretched…be cautious

Posted on November 15, 2011 by Donald Stoltz

I was building out some internal charts recently and ended up creating a spread between the bull and bear sentiment indices (using the AAIIBULL and AAIIBEAR Index). Basically it shows investors bullish sentiment in 6 months time (the higher the number the more bullish).

Extreme sentiment tends to be a contra indicator, but it’s interesting to see the actual data. Five out of the last six times the indicator was above 20 we’ve sold off over the next 6 months. When the index was sub -30 (ie bearish) it’s a little less predictable (3 out of the last 5) and returns were much more volatile, but still interesting. Now that we’re breaking above 20 again it could be telling. Also, notice the one time it was wrong was early Sept ’10…when QEII changed the rules of the game.