How AAII can help explain yesterday's rebound
2min read The latest AAII Investor Sentiment Survey revealed a notable drop in bullish sentiment, which fell to 39.8% from 45.3% the previous week, marking its lowest level since June. This decline reflects a cautious market tone that has developed over the past few weeks, as bullish sentiment has steadily declined from a recent high of 51.2%. The drop in optimism coincides with yesterday’s market rebound, as the absence of strong bullish conviction may have prompted some investors to step aside, allowing "buy the dip" participants to take control. The lower bullish sentiment suggests that some of the excessive optimism was tempered, creating conditions for yesterday’s reversal.
In addition to the decline in bullish sentiment, bearish sentiment rose sharply, jumping from 24.9% to 31.0%. This surge in pessimism reflects a more cautious market outlook, similar to the sentiment spike seen in early August during a period of heightened uncertainty and market volatility. The bull-bear spread now sits at 8%, which, outside of August, is the lowest level since early June. This narrower spread signals growing caution among investors, and while it explains the recent market move, it may not necessarily predict future direction, as investor sentiment can often swing rapidly.
Historically, September has been a challenging month for market sentiment, and the AAII survey data hints at potential seasonality. In both 2022 and 2023, the bull-bear spread fell into negative territory during September, with a particularly steep drop occurring in 2022. The spread reached its lowest point of -26% in November 2022, which coincided with the market bottoming after a seasonal selloff. While the current spread is still positive, the recent decline bears watching closely, as it may foreshadow further shifts in sentiment as the month progresses.
This week’s special AAII question asked participants whether they were postponing investment decisions until after the upcoming November election. A majority of respondents (60%) said no, indicating that geopolitical uncertainty is not significantly affecting investment decisions at this point. A smaller group, 16%, indicated that their decision could change depending on election outcomes, but for now, the general sentiment appears stable. This suggests that, despite looming political events, most investors are not making major adjustments to their portfolios, indicating an expectation of minimal disruption from election results.
Sentiment data, such as the American Association of Individual Investors (AAII) survey, can often be counterintuitive because it reflects investor emotions, which tend to be reactionary rather than predictive. When a large portion of investors are bullish, it can suggest that optimism is already priced into the market, potentially signaling limited room for further gains. Conversely, when sentiment is overly bearish, it may indicate that most investors have already sold, creating the potential for a market rebound.
This counterintuitive relationship is often attributed to the "contrarian" theory in investing: extreme levels of investor sentiment, whether optimistic or pessimistic, can precede a reversal in market direction. For instance, during periods of extreme bullishness, markets may be near a peak because most investors have already committed capital, reducing the pool of new buyers. Conversely, extreme bearish sentiment may signal a market bottom, as fear drives excessive selling, leaving room for a rebound when sentiment turns. Therefore, sentiment indicators are often used as contrarian signals, guiding investors to act against the prevailing mood.