A sentiment signal with a perfect record just triggered

Key points:

• The Advisor and Investor Model (AIM) cycled from below 5% to above 75%
• Similar sentiment shifts saw the S&P 500 advance 100% of the time over the next six months 
• With seasonality suggesting a mid-September consolidation, get ready to buy the dip

A return to optimism

The Advisor and Investor Model, a composite sentiment gauge that blends several measures, has staged a dramatic rebound in recent months. From registering just 1% at the depths of the April low, a level reflecting near-universal pessimism, the model ticked above 75% by the end of last week. 

Such a swift transition from extreme fear to broad-based optimism underscores how decisively investors have embraced the rally.

As we've noted before, bullish sentiment isn't inherently bearish; like valuation, it's a precondition. The risk arises only when optimism reverses from an extreme. The table below shows this dynamic, with AIM readings of 75% yielding an annualized return of 9.5%, exceeding the results when the composite ranged between 25% and 75%. 

A disproportionately positive outlook 

Whenever the AIM indicator rose from below 5% to over 75% and the S&P 500 traded less than 5% shy of a five-year high, the S&P 500 advanced without fail over several horizons. 

For investors wary of stretched valuations or bubble talk, it's worth noting that after a similar signal in 1998, when the Shiller CAPE ratio was at comparable levels, the S&P 500 gained 18% over the following year. 

Over the next year, the S&P 500 experienced a decline of more than 10% on two occasions, while it rose by more than 10% in eight instances, indicating a favorable risk/reward profile.

Seasonality 

Seasonality for the S&P 500, shown in the chart below, generally peaks in mid-September, coinciding with the September quad witching event, before declining to a trough around mid-October. Investors should use any consolidation during this period to position for a year-end rally.

In the seasonality section on the website, you can zero in on specific events like quad witching, FOMC decision days, and several other options. 

Let's take a look at September quad witching, which refers to the simultaneous expiration of four types of derivative contracts.

The tables below detail performance around quad witching days, highlighting September's pronounced negative bias in the four sessions following Friday's expiration. 

Backtest Engine

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What the research tells us...

The Advisor and Investor Model, a composite measure of market sentiment, recovered from extreme pessimism, cycling from below 5% to above 75%. This move reflects a transition in investors' risk appetite. Historically, similar sentiment shifts near a 5-year high have produced outstanding returns and consistency, with several intervals achieving a 100% win rate. 

With seasonal headwinds approaching, any weakness or consolidation over the next month should be viewed as an opportunity to position for a year-end rally.