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The Last Time This Indicator Flashed Red Was in 1987

By Chris Lowe, Editor-at-Large on September 5, 2014

Whether markets are efficient or not, they often reach inflection points at extremes in sentiment.

In other words, when everyone has turned bullish, there is nobody left to buy… and prices tend to fall. And when everyone has turned bearish, there is nobody left to sell… and prices tend to rise. 

One widely watched sentiment indicator is the weekly US Advisors’ Sentiment Report, published by Investors Intelligence. 

It looks at more than a hundred independent newsletters and assesses each author’s stance on the market: bullish, bearish or correction. 

The norm is about 35% bears. But as you can see from the chart below, the number of bears just came in at only 13.3% – the lowest level since February 1987. 

 
Source: Ryan Detrick’s Tumblr
This doesn’t mean a crash is imminent. The S&P 500 gained 16.6% in the six months following that last record low in bearish sentiment in 1987, before the 20% one-day crash that followed in October.

But from our perch, it’s another sign that US stocks are becoming a worryingly crowded trade… and that returns from here are likely to be disappointing.

This is certainly the lesson of recent market history. If you look, for example, at all the times the bears dropped below 14% going back to the 1970s, you’ll see that the following average 12-month returns for the S&P 500 were just 0.7%.

That’s not disastrous. But it’s hardly stellar either.

We continue to prefer markets that are deeply out of favor to markets in which sentiment is at extreme lows.

That’s why Russia and China continue to be firmly on our radar of compelling contrarian buys.

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