A recent survey by the American Association of Individual Investors has shown an increase in stock market sentiment, rising from 28.0% to 41.7%. This represents the largest surge since January and the highest level since reaching 45.0% on July 3rd, matching a yearly peak.
While this increase is not an immediate sell signal, it is above the long-term average of 37.5%, a milestone not seen in seven weeks. Bearish sentiment, however, remains high at 42.4%, surpassing the average of 31.0%.
Historical Bullish Sentiment
Historically, the all-time high for bullish sentiment was 75% during the dot-com bubble peak in January 2000. In April 2021, bullish sentiment reached 56.9%, preceding a market peak in December of that year.
Another peak occurred in July 2024, achieving 52.7% bullishness, before a rapid 9.7% correction happened. This downturn paused when the Federal Reserve indicated a potential rate cut.
Monitoring this sentiment indicator is advised, especially if it rises above 50% or 55%, as these levels may indicate market volatility.
With bullish sentiment seeing its biggest weekly jump since January, we are now in frothy territory as the S&P 500 pushes near 6,150. This level of optimism, now above its long-term average, often precedes market pullbacks. We only need to look back to the summer of 2024 to see how a sentiment peak was followed by a sharp correction.
Strategy for Portfolio Protection
This suggests it is a good time to consider buying some portfolio protection before it gets expensive. The CBOE Volatility Index (VIX) is currently sitting near 13.5, which is historically low and indicates complacency in the market. This makes buying options relatively cheap compared to periods of market stress when the VIX can easily spike above 20 or even 30.
Specifically, looking at out-of-the-money put options on the SPX or QQQ for October or November could be a prudent move. This provides a cost-effective way to hedge against the kind of 5-10% downturn that we experienced last year. The goal isn’t to call a market top, but to insure the portfolio against a very possible dip.
However, we should note the high reading for bearish sentiment as well, which sits at 42.4%. Such a sharp divide between bulls and bears suggests market disagreement and could lead to an increase in volatility. This environment makes strategies that profit from price swings, such as VIX calls or long straddles on volatile tech names, potentially attractive.
Unlike the pullback in 2024 which was met with clear signals for rate cuts, the situation is now more complex. The Federal Reserve is on pause, and the latest CPI report showed inflation ticking up slightly to 2.9%, making further intervention less likely. This economic uncertainty reinforces the need for derivative hedges rather than assuming a quick “buy the dip” rebound.
