To The Moon

Summary

• The granddaddy sentiment indicator - Investors Intelligence - suggests a major stock market correction is coming later this year.
• The indicator shows that there are currently far too many bullish newsletter writers, indicating extreme bullish sentiment.
• We believe it will begin later this year, with a decline of 15% or more in the S&P 500, and last through most of 2025.
• A balanced portfolio of stocks, long-term AAA bonds and cash should neutralize most of the risk and also expose one to price gains if this forecast proves early or incorrect.

Ljupco/iStock via Getty Images

Investors Intelligence, the granddaddy of all sentiment indicators with a history back to 1964, is signalling stock market caution. Preliminary estimates suggest a correction should begin later this year, decline a minimum of 15% and last through most of 2025. A balanced portfolio of 50% stocks, 25% long-term AAA bonds and cash should neutralize most of the risk but also expose one to further price gains if this forecast proves too early or incorrect. For those who believe in gold, add 7%.

Investors Intelligence – The Granddaddy Sentiment Indicator

Investors intelligence has been monitoring the bullish or bearish opinions of stock market newsletter writers since 1964. This long history has made it the premier indicator of investor sentiment over the years. Almost all top market technicians, including the great Alan Abelson, former long-time editor of Barron's Magazine, have referenced it at one time or another over the years.

Investors Intelligence is a classic contrary opinion indicator. History has shown that it's troublesome when "too many" newsletter writers are forecasting a bull market. Likewise, one should be optimistic about stocks if "too many" newsletter writers are forecasting a bear market.

This forty-four year chart of Investors Intelligence, plotted against the Dow Jones Industrials, shows the general truth of these observations.

A forty four year chart of the ratio of "bearish to bullish" newsletter writers (The Sentiment King)

The red curve graphs the ratio of the number of bearish newsletter writers to bullish writers. The black line represents when the numbers are one for one, so any ratio above that line represents more bears than bulls. It's easy to see that, on average, newsletter writers are more bullish than bearish since, as you can see, the ratio is normally below the line. This is as it should be.

We've indicated, with arrows, six times in the last 44 years when the ratio showed excessive numbers of bearish newsletter writers, and each occurred just before a major bull market. This isn't just hindsight. I have video copies of a December 1994 client seminar where I showed 100 people this exact same chart, pointing out the buying opportunity. This moment is indicated by the third arrow from the left, which was one week prior to the start of the five year, dot com bull market.

The last signal occurred in 2022 (far-right arrow) and we wrote about it in this December 2022 article titled: The Granddaddy Of All Sentiment Indicators Is Signaling A Bull Market.

"Too Many" Bullish Newsletter Writers Have Generated A Red Zone Reading

Right now, we have the opposite extreme - there are simply too many bullish newsletter writers. We’ve circled it in red. It’s easier to see this if we graph the ratio on the Sentiment King red and green zone ranking scale shown below.

Investors Intelligence plotted on the Sentiment King Red and Green scale which shows where values are against historic extremes (The Sentiment King)

Green Zone readings represent extreme bearish sentiment, while Red Zone readings indicate extreme bullish sentiment. It's the same data as the first chart but put on a scale which shows where the ratio is against historic values. Red and Green Zone readings occur when the ratio is 10% or less of its historic extremes, either way.

As we said, Green Zone readings almost always occur before a major bull market. There are very few exceptions. That's not true of Red Zone readings. We've had major bear markets begin without first reaching a Red Zone reading. However, when a Red Zone reading did occur, it almost always resulted in some major correction in the market.

For example, it went to a red zone reading before the 1987 market crash. In recent times it went to red zone readings in 2014 and 2015 prior to the 20% bear market of 2015. It also went to a red zone reading at the market peak in 2018, and again in 2021 before the 2022 bear market.

We’ve circled in red the most recent red zone reading, when 62% of writers were bullish and only 14% were bearish. This extreme in opinion has only happened 1% of the time in the last forty-four years, so it’s very rare. This, plus signals from other similar indicators, strongly suggests the market is headed for a correction.

Why the Theory Works

Contrary opinion, as a theory, was first defined by Humphrey Neill in his 1954 book, The Art of Contrary Thinking, but I'm sure it was known before that. For example, in Edwin Lefevre's book, Reminiscences of a Stock Operator, written over 100 years ago, there is the statement, "Always buy when complete demoralization has set in."

The usual explanation of why the theory works is this; if everyone is bullish, investors have already purchased so even with additional positive, economic news, there are few buyers left to push prices higher. The price advance is “exhausted” so to speak. So just a little profit taking by current investors will move prices lower. Remember, data doesn’t drive prices higher, buyers do.

On the other hand, if everyone is bearish, they have already sold. So, even with more bad news, there are few sellers left to push prices lower. The market is “washed out.” Therefore, just a little buying by bargain hunters will move prices higher. This is pretty much what happened in the latter half of 2022.

This explanation of the theory is good, but it doesn't account for everything. For example, I have seen markets that went through a small sideways correction after a big advance, which ended with almost everyone expecting prices to decline even further. Yet, the number of possible sellers couldn't possibly be exhausted after such a small correction, like at the end of a bear market.

Until we get a better explanation, however, this one will suffice.

Stay Balanced

Our best estimate is that a market correction will begin later this year. We think it will be a decline of 15% or more, and last through most of 2025. The Dow should stay within the bounds of the two parallel trend lines shown in the chart. This combination will be make it both a "time" and "price" correction.

We believe a balanced portfolio of 50% stocks, 25% long-term AAA bonds and cash should neutralize most of the risk, and also expose one to further price gains if this forecast proves too early, or incorrect. This should be true whether a market decline and a drop in interest rates is caused by a recession or an unexpected global crisis. Either way, the rise in long-term AAA bond prices because of a drop in rates should help offset any decline in stock prices.