(08/30/13) Contrarian's Bullish Sentiment Signs

Sentiment polls have showed some amazing spikes, in fear on a less-than-5% pullback; as contrarians, this is exactly what you want to see, asserts Ryan Detrick, senior technical strategist at Schaeffer Investment Research.

Sentiment polls showed some amazing spikes, in fear on a less-than-5% pullback. As contrarians, this is exactly what you want to see. It doesn't mean the market has to bottom here and now, but it increases the odds of a lasting rally, once we get moving again.

First up, the American Association of Individual Investors (AAII) poll saw bears spike 52% in just one week, from 28.2% to 42.9%—the most bears since April 18. The bulls dropped to 29%—the lowest since mid-April.

This is significant because mid-April was a time to be accumulating stocks, right in front of the surprise May rally. Lastly, the bears have actually advanced for six consecutive weeks. This has never happened since the poll started back in 1987.

The Investors Intelligence poll saw those looking for a correction move over the critical 35% area to 35.1%. As you'd expect, when everyone is looking for a pullback, the odds of it happening are slim. We've crossed this percentage line two other times this year, and both marked short-term buy signals.

In fact, going back to 1980, the percentage of Investors Intelligence respondents expecting a correction has topped 35% just 28 times, and the (SPX) is up an average of 1.93% a month later, and up 75% of the time. The three-month return averages a very solid 3.75%, with the SPX up 70% of the time.

Another poll reflecting a huge spike in worry was the National Association of Active Investment Managers (NAAIM) survey, which asks money managers to provide a number that represents their overall equity exposure as of Wednesday's close each week.

The latest poll actually suffered its biggest drop since January 2008, falling from 69.85% clear down to 34.76%. This is near the June lows and presents a nice buying opportunity. The bottom line is: Active managers have plenty of cash to put to work; the only question is, will they?

It doesn't end there, though, as investors are speaking with their actions. According to BofA-Merrill Lynch, just two weeks ago, we saw the largest outflow from US equity mutual funds in over five years! Amazing what a small pullback and worry over Fed tapering can do to investors' psyche.

Now there are some worries—it isn't all great. One of our biggest concerns is the 10-day moving average of the all-equity, customer-only, buy (to open) put/call volume ratio is near its lowest level since April 2011, which marked a major peak before a near-20% correction. The lower this ratio, the more optimism there is among option speculators.

The action in housing stocks is another concern. The iShares Dow Jones US Home Construction Index Fund (ITB) is in the midst of making a very bearish-looking head-and-shoulders peak.

Meanwhile, the Dow Jones Industrial Average has broken its uptrend line from the November lows. Other indexes have held up better, but this is another concern.

Historically, August and September are two of the weaker months, and so far, August has lived up to that. In fact, going back 30 years, they are hands-down the two weakest months, with the dreaded September the worst.

If you look at more recent data, though, September surprisingly isn't that bad. In fact, the SPX is up seven of the past ten Septembers, and is actually positive on average. Should we see more of a dip in stocks, and with a spike in worry over September looming, that could be a positive.

Remember all the Sell in May worries? That didn't play out at all, as May saw a nice move higher. I'd say there's a chance that could happen once again in September. In conclusion, we continue to recommend buying dips.