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Will Retail Investors Trigger the Next Major US Stock Market Rally?

The coronavirus pandemic induced business shut down in March 2020 continues to wreak havoc on the US economy. The Department of Labor reported today that another 2.123 million Americans filed for jobless claims this past week. Over the last 10-weeks, a staggering 40.8 million Americans have filed for unemployment benefits. This would imply one in four US workers are out of work today. In addition to the 2.123 million regular unemployment claims for benefits, another 1.2 million Americans that do not qualify for normal unemployment benefits filed for government jobless assistance this past week.

Although the weekly jobless claims may have peaked during the last week of March with a record 6.648 million claims during 3/23/20 to 3/28/20, the above unemployment statistics coupled with the US GDP contracting 4.8% during the first quarter and a greater decline during the second quarter this paints a dire US economy. Historic mass unemployment rate and an imminent official US recession, interestingly, the US stock market has rallied sharply from its 3/23/20 low. For instance, SPX has gained 40% and the Nasdaq NDX index has jumped 41.33% from their respective March lows.

So, is the stock market, which is a leading indicator of US business cycles suggesting the worst of the COVID-19 pandemic condition is behind us?

The weekly AAII Investor Sentiment survey is a widely followed measure of the mood of individual investors and is followed by many financial professionals and market strategists. Since it is a popular contrarian indicator it is an important sentiment indicator to monitor for pivotal turns in the stock market and the US economy. For the week ending on 5/27/20, the AAII survey shows the Bullish sentiment at 33.1% or slightly below its historical average of 38.0%. The Bearish sentiment is at 42.1% and is far above the historical average of 30.5%. The Neutral camp is currently at 24.8% or just below the historical average of 31.5%.

The bearish sentiment is at a generally high level for the past 11th consecutive week. The bullish sentiment has moved back to its typical historical range. It is interesting to note that despite the 40% rally in many key US stock market indexes the continued high level of pessimism in US retail investors is likely the result of several important factors.

The uncertainties and the concerns of the impact on the coronavirus pandemic are adversely impacting the psyches of retail investors. Based on the AAII member responses it is reasonable to say that many retail investors are not convinced about the stock market recovery and believe the current stock price prices are inflated or overvalued. Another major factor is retail investors also fear the recent stock market recovery is the direct result of the unprecedented injection of liquidity into the financial system via monetary (FED) and fiscal stimulus (US Government). When the stimulus end, they believe this will led to another major market sell-off. Other factors influencing the overly defensive views of AAII members include the uncertainties surrounding the November US presidential election, escalation of the trade war with China, and stock market bubble developing.

The question then becomes is the overly pessimistic views from retail investors (AAII members) a contrarian indicator that suggests the US stock market may be climbing the wall of worry. Or is the retail investors correct to worry about another major market sell-off in the immediate future?

Attached is the monthly chart of the AAII survey dating back to 1987. It is important to note that the AAII Bull/Bear Ratio (0.79) and the AAII Bull-Bear Spread (-9.00) are both rebounding from their respective extreme lows (interpreted as extreme bearish sentiments). Based on the contrarian nature of this sentiment survey this would imply the US stock market may have further upside potentials. Will retail investors be the trigger for the next major US stock market rally to new all-time highs?

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