Latest AAII Sentiment Reading is Out of this World

This week's AAII sentiment survey is out, and the bullish sentiment is out of this world: 63% bullish and only 16% bearish, for a bull-bear spread of 47%!

This is the highest percent bullish since November 18, 2004 - after which the market flat-lined for almost a year until October 2005. It is the lowest percent bearish since November 24, 2005 - after which the market flat-lined until July 2006. It is the highest bull-bear spread since April 15, 2004 - after which the market flat-lined until October 2004. The four week moving average of the bull-bear spread is the highest since December 15, 2005 - after which the market essentially flat-lined until June 2006.

The three major sentiment indicators that I follow - call buying, the AAII survey, and insider transactions - have an excellent track record. Getting out of the market during extreme positive sentiment would have kept you out of Black Monday in 1987 (the biggest one-day percentage decline in history, -23%), the tech bubble crash in 2000 (a 42% decline, peak-to-trough), the October 2007, May 2008, and April 2010 peaks, plus a host of other smaller peaks that followed various relief rallies.

In terms of predicting crashes, these indicators together have no false negatives. A "false positive" means missing a period when the market trades in a small range (flat-lines) for six months or a year.

As Hussman commented last week, "the return/risk profile of the equity market is the most negative that we ever observe historically".

The 2008 crash did not teach the big, baby-boomer (i.e. only bull market experience) asset managers anything. Bill Miller at Legg Mason (down 50% over the past 10 years!) thinks there is "a lot more to go" [pdf], and Ken Fisher thinks bears are "idiotic". Even USA Today thinks you should be back in stocks.

Investors are experiencing an extraordinary delusion. They wrongly believe that inflation is bullish for equities, when actually it lowers earnings multiples and, for many companies, hurts earnings. They refuse to acknowledge the European debt crisis (which affects all world financial institutions), or the incipient U.S. municipal bond crisis.

The country is gutted, but meanwhile, we have another dotcom bubble complete with business model-lite companies, a farmland bubble, a precious metals bubble, and a generational bubble in ugly and degenerate art.