Charles Rotblut, VP of the AAII

“Buy when there is blood in the streets, even if the blood is their own.” Baron Rothschild.

Yesterday, the Wall Street Journal had an interesting article  about the weekly resurvey released by the Association for Individual Investors (AAII). The AAII asks 200-300 investors once a week whether they are bullish, neutral or bearish on the stock market.

The article criticuqed the methodology used in the survery since it only questions 0.2% of the association’s 150,000 dues-paying members. Also, most people who answer the question are likely retirees and therefore the poll does not get a full spectrum of investors.

However, the article did note that the survery is a great contrarian indicator. The survery has data going back to 1987 right before the big crash and has therefore been in existence for 23 years.

During those 23 years the survey has shown that it is always good to do the opposite of “the dumb money” (although many “professional investors” are as clueless as individual investors themselves).

On March 5th 2009 the AAII survey registered its lowest bullish reading in 17 years. The next day the market shot up significantly and went up a total of 80% in the next 13 months.

The article further noted On the 16 occasions since the early 1990s that bears have outnumbered bulls by at least 10%, the Standard & Poor’s 500 has gone on to rally an average 6.2% gain over the next six months. And vice versa when bulls outnumber bears by at least 30%, the S&P 500 has tended to fall over the next six months.

Right now the current readings are 49.66% bullish (well above the historic average of 39%) and 26.21% bearish.

I have looked at further historical data (before the article came out) with the help of my colleague who runs http://seekingdelta.wordpress.com/. The data seems to indicate that the AAII survey is a great indicator. It usually peaks right before the market crashes, and sentiment reaches its low right before a big bull market. I have decided to include the data in my monthly market valuation series. I will start including it in the next article which should be released around January 1st, 2011.

About the fact that only 0.2% of investors are surveyed, so what. If you had a pollster who everyone criticized his/her methodology but the pollster always predicted who would win the election would you throw the data out the window? I think not.

I would also say that retirees’ sentiment on the market will be slightly if not different at all from younger groups of investors. The reason is that we are all prone to fear and euphoria when we are investing. It does not matter if you are 15 or 75 you still have the same human instinics.

The article in the WSJ quoted  David Madigan, professor and head of the Department of Statistics at Columbia University stating the survey is  “pretty much useless”. Really? I beg to differ based on all the evidence of the past 23 years. I would like Dr. Madigan to explain his answer to that question.

http://seekingdelta.wordpress.com/ publishes his commentary on the survey on a regular basis. As stated above it will now be included in my monthly market valuation series. Stay tuned because although there might be individual stocks that are cheap, the AAII survey is a good indicator for the overall broad market. If this is correct be especially careful now to buy stocks with a margin of safety