The number of bulls is dwindling. In periods of extreme market volatility such as we have experienced in recent weeks—and Friday, January 15, 2016, in particular, when the Dow was down over 500 points at one point before paring losses—we find it helpful to try to take some of the emotion out of our investment decisions. As difficult as that can be at times, this approach can help us reduce the chances of selling at the bottom, even though the natural reaction for many is to panic and hit the sell button.
One way to help measure how close to the bottom stocks may be is to use sentiment indicators to identify extremes in bullishness and bearishness. When the bulls are all washed out, in theory, there are few sells left to put more pressure on stocks. In this case, extreme bearishness can be viewed as a contrarian indicator and may signal that selling could be near an end.
Technical analysis can also help identify key price levels that may signal breaks in either direction. These tools can give us an idea of when the selling might stop and a reversal might ensue. An objective look at some data can be reassuring and help us make better investment decisions.
A closer look at sentiment indicators suggests most of the selling may be behind us. We haven’t seen full panic—or capitulation—but we have gained some confidence that the upside opportunity for stocks may outweigh the downside.
FEW BULLS LEFT
The latest American Association of Individual Investors (AAII) survey indicates an extreme scarcity of bullish investors, even more extreme than was observed in the summer of 2015. In fact, based on the latest AAII survey, bulls are as scarce as they were in 2009 and 2003, the last two major market bottoms. The reading of bulls during the latest week came in at 18%, the lowest level since April 2005. Bears have spiked as well, up to more than 45%, the most since April 2013.
Using weekly data, the eight-week moving average of the bulls is below 26% [Figure 1]. For comparison, this was the lowest since March 2009 during the depths of the financial crisis. The only other time it was less than 26% over the past 20 years was March 2003. This extreme level of bearish sentiment may suggest a lack of new sellers and that stocks may be nearing a bottom.