Sentiment Signals: A call for caution

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The results of the AAII Investor Sentiment Survey are shown in the graphs below. The Survey measures the percentage of individual investors who are bullish, bearish or neutral on stock market for the next six months. As the masses are usually on the wrong side of market movements, particularly at tops and bottoms, sentiment indicators fulfil a useful function as contrarian indicators.

The bullish sentiment (55.9%) and bearish sentiment (18.3%) readings are at fairly extreme levels, as also seen from the bull-bear spread being quite a bit higher than the market peak of October 2007.

Sentiment indicators are fairly blunt instruments from a timing point of view and can stay at high / low levels for extended periods. However, when companies are overvalued and technical indicators overbought, overbullish sentiment indicators complete a threesome of tools arguing quite strongly for a cautious approach to stock market investment.

Source: AAII Investor Sentiment Survey; Plexus Asset Management.

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