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The Recent Extreme Level of Pessimism Should Engender Optimism

Many investors are not convinced that this recovery from the August 24 low is for real. They worry that the October surge is just a “bull trap,” in which bulls will be enticed back into the market just before it reverses course and falls to an even lower low.

Yet at the end of September 2015, the percentage of stocks in the S&P 500 trading above their 200-day moving average, known as its bullish percentage, fell below 20%. This extreme level of bearishness has been seen in only six other periods in the past 30 years – the bear markets of 1987, 1990, 2000, and 2007, as well as the corrections of 1998 and 2011.

S&P 500 Bullish Percentage and Bear Markets and Corrections

The average price change in the subsequent three, six, and 12 months were gains of 5.5%, 12.5%, and 17.4%, respectively. What’s more, the frequency with which the S&P 500 rose in price in those subsequent periods were greater than 80%. Only during the bear market of 2007 did a BP below 20% offer premature bullish signals.

So only if the correction of 2015 morphs into a new bear market rivaling that of 2007 (an eventuality that S&P Capital IQ does not anticipate) should we worry about having received a premature all clear signal.

By the way, I was taught long ago by an S&P colleague that “bear trap” is a misnomer. If a human sets a trap to catch a mouse, it’s called a “mouse trap,” not a “human trap.” So if the bears set a trap for the bulls, it’s a “bull trap,” not a “bear trap.”

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