Are your emotions too optimistic? | decision point

(This is an excerpt from today’s subscriber-only broadcast. DP warning.)

Today I thought it would be a good idea to examine my emotions. It’s no surprise that investors are very optimistic right now, but how optimistic are they? Am I being too optimistic? The charts tell us one thing for sure. That said, based on history, sentiment may become stronger. Remember that sentiment is contrarian, so very optimistic sentiment is not necessarily good for the market.

The first is the National Association of Active Investment Managers (NAAIM) Exposure Index. Those surveyed primarily use technical analysis in their processes, so it was interesting to see how exposed or utilized they are to the market. Considering the last two readings at this level have declined, we have definitely reached exposure levels that could cause problems. At the same time, readings can be much higher than they are now, which does not always spell disaster. It’s interesting to note that these analysts are very bullish and almost fully invested, yet untapped.

The following is a chart from the American Association of Individual Investors (AAII). Here we can see extreme strength, as evidenced not only by the amount of strength, but also by the bullish/bearish ratio. These high ratios often precede declines. The 2020-2021 rally has not been hampered by these high rates and may be again this time, but this chart tells us not to let our guard down just yet.

Finally, let’s take a quick look at the Rydex ratio chart. This is an indicator of ‘money where your mouth is.’ We don’t look at poll results, we look at actual dollars. We take the total number of bullish assets and divide it by the total bearish and money market assets. Bull assets have increased significantly, but not at levels seen before, so there is room for expansion. However, we should note that bull assets at this level often lead to a decline.

conclusion: Optimistic feelings abound, but they are not as optimistic as they can be. Given the strength of the current rally, I think we will see higher bullish sentiment readings. If the 2021 rally is any indication, this measure of sentiment could be extended and not lead to a decline in prices.

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