The 'Panic of 2014', a hedge fund driven decline thus far, has yet to rattle the individual investor. The latest sentiment survey from the American Associate of Individual Investors (AAII) reports sizable rebound in bullish sentiment from the October 15th low. This surge, illustrated by an increase in normalized sentiment from -0.13 to 1.35 from October 16th to October 23 (chart), has also been confirmed sharp decline in the VIX (Equity DI). While opinion-driven bulls 'see' this sentiment shift as an endorsement of the rally, they omit it's horrible timing record from the discussion. As state numerous times on Insights, investor sentiment's track record as a timing tool is so bad, it's useful as a contrarian indicator.
Normalize sentiment readings above 1.96 depict extreme bullish sentiment. This setup, an indication of instability driven misplaced optimism of the majority, reflects a growing instability behind price and increases the probability of an unexpected price reversal. Today's normalize sentiment reading of 1.35, the second highest reading since August 2014, reflects a market trending towards instability despite a modest panic decline. This is unexpected and concerning.
Panic declines, even moderate ones, shift control of the trend from the weak to strong hands. This shift in control usually generates a bearish sentiment shift (from optimism to pessimism towards stocks). A market trend towards optimism despite the modest panic suggests an incomplete transfer of control. If this runs to completion, the strong hands will gain control as prices decline. In other words, the panic of 2014 may not be done.
