Contrarian Indicator Flashing Amid Bullish Sentiment

The spike in bullish newsletters has been a contrarian indicator in the past

The recent all-time high for the S&P 500 Index (SPX) caught the attention of market newsletters. Investors Intelligence (II), which tracks over 100 stock market newsletters categorizes each as bullish, bearish, or expecting a correction (short-term bearish but long-term bullish). Last week, the percentage of bullish newsletters jumped to 51% from 39% the previous week.

The 12% increase was the biggest one-week jump since 1980. Could this surge in newsletter optimism lead to increased public buying? In this week’s article, I look at what has typically happened after these sharp jumps in sentiment. Then, I adjust the historical data to fit the current market environment.

Moderately High Bulls

We have data on the II survey since 1972. The table below summarizes how the S&P 500 performed over the next month, based on percentage of bullish newsletters in the II sentiment survey. The bracket ranges were formed so that each bracket has the same number of returns. Unfortunately, the recent spike to 51% puts the figure in that 49% to 55% range, which is the range in which the index has performed the worst. Over the next month, the SPX averaged a return of 0.22%, with 57% of the returns positive.

The second table below takes a longer-term look, summarizing the six-month returns of the index. Again, the worst SPX returns for average return and percent positive, occur in that 49% to 55% bracket which contains the recent reading. The tables indicate the II poll is a contrarian indicator and the high number of bullish newsletters means we might temper our expectations going forward.

Jump in Bullish Newsletters

One question I had was whether the spike in bullish newsletters created buying pressure, as the public read the arguments to buy stocks. The data below supports this theory. After a one-week jump in bullish newsletters by 10% or more, there is outperformance going forward, especially in the shorter term. For example, in the two months after the spike, the SPX averaged a return of 2.6% compared to a typical return of 1.48% for that timeframe. There’s outperformance after a spike in each of the timeframes out to six months. However, there’s underperformance after one year.

We see above, there were 46 times the percentage of bullish newsletters spiked by 10% or more in one week. Before that, I showed that the II poll was a contrarian indicator with better returns for the market when the percentage of bulls was lower rather than higher.

This next table shows SPX returns after a 10% spike in the II bullish newsletters in which the percentage of bullish newsletters was above 49%. So, it’s in those bottom two buckets in the first couple of tables above. This situation has led to more bullish returns over the first month with the SPX averaging a return of 1.37% and 54% of the returns positive. Compare this to the typical one-month return of 0.73% since 1972 (see above) or compare it to the average return in the second table below of 0.90% which is when there’s a spike but the percentage of bulls is less than 49%. After the month of outperformance, however, the returns at the longer time frames are similar to returns after other spikes in newsletter optimism.

In conclusion, the survey of investment newsletters put out by II has been a contrarian indicator. We recently saw a large one-week spike in the percentage of bullish newsletters. The raw reading is now moderately high, putting it in a range where the historical data shows lower than normal stock returns going forward. However, after a large spike, even one in which the bullish newsletter percentage was high, the SPX tends to outperform typical returns. It’s possible that the spike in bullish newsletters leads to new buying as their bullish arguments get consumed by investors.