- Almost 40% of investors are neutral right now (not bullish or bearish).
- After high neutral readings, stocks are higher six months later 83% of the time.
- $3.2 trillion is sitting in money markets, just waiting to add fuel to the bull market.
JPMorgan Chase analysts say the probability of recession in 2019 is 40%. That’s up from 25% in early May.
Morgan Stanley, Goldman Sachs and independent analysts are also concerned. Even the Federal Reserve is preparing to cut interest rates in response to a slowing economy.
All this nervousness is bullish.
Investors buy or sell based on how they feel. When they’re optimistic and bullish, they buy. Pessimism leads to selling.
Nervousness leads to inaction. That means cash builds up in accounts, ready to fuel the next leg up.
And that’s not just my opinion. This is all backed up by data.
One source of data is surveys like the one done by the American Association of Individual Investors, or AAII.
Every week since 1987, AAII conducts a survey. There’s just one question: Are you bullish, bearish or neutral about the next six months?
The data are surprisingly useful.
Extremes in the Data
In an average week, 38% of investors are bullish, 30% are bearish and 32% are neutral.
Last week, about 30% were bullish, 32% were bearish and 38% were neutral.
The chart below shows recent trends.
Extremes in the data are important. Notice the percent of bears rose in December. Prices bottomed while most investors were bearish.
History confirms that wasn’t a fluke. When more than 50% of investors are bearish, a bottom is usually close. When more than 50% are bullish, tops are common.
That’s because bears sell and bulls buy. By the time most investors are bearish, they’ve already sold.
Bear markets end when we run out of sellers. Prices rise as selling pressure disappears.
Likewise, when most investors are bullish, they have already bought stocks. By that time, there aren’t many sitting around looking for stocks to buy.
Basically, the bull market ends when we run out of buyers.
The Odds Favor Higher Prices
Surveys like AAII’s help us spot the potential buying and selling power that’s on the sidelines.
The chart above shows almost 40% of investors are neutral right now. This indicates they’re neither buying nor selling.
Instead, they’re building cash reserves. They’ll buy stocks when they’re more optimistic.
Research shows this is the most bullish scenario for the stock market.
High neutral readings in AAII’s survey are bullish. On average, in the six months after a high reading, the S&P 500 Index gains 65% more than it does in a random six-month period.
After high neutral readings, stocks are higher six months later 83% of the time. In a random six-month period, the probability of a gain is 68%.
The odds favor higher prices in the stock market by the end of the year. Other data show the gains could be substantial.
Fuel for a Bull Market
Data from the Investment Company Institute show individuals are holding $1.2 trillion in money market funds. Institutional investors have an additional $2 trillion in money markets.
Think of cash as the fuel for a bull market.
The amount in money market funds is equal to 10.4% of the stock market’s value. As this cash flows into stocks, major market averages will rise.
It looks like the number of neutral investors peaked a few weeks ago. With the percentage starting to decline, the data say now is an ideal time to buy.
Michael Carr, CMT, CFTe
Editor, Peak Velocity Trader