Pity the average investor. They tend to jump into and out of the stock market at precisely the wrong times. In late August, I looked at the weekly investor sentiment poll conducted by the American Association of Individual Investors (AAII) and noted that most investors feared a big market tumble. [Read that article here]

Historically speaking, you want to start buying stocks when most individual investors are shunning them. And that has once again proven to be the case. Since that August swoon, the S&P 500 has risen +14%. And like clockwork, that impressive performance has turned individual investors from bears to bulls.

In the week ending November 10th, 57.6% of retail investors were bullish, according to the latest AAII poll. That’s up +9.3 percentage points from the prior week, and the most bullish reading since January 2007.

So if bearish sentiment is always good for stocks, is bullish sentiment always bad for stocks? I pored over 25 years’ worth of data to gauge the market’s subsequent returns every time investors were more than 55% bullish. The results are mixed…

An unusual spike
To put that 57.6% bullish figure in context, there have only been three such weekly readings in the past five years. The only time investors were at least 55% bullish in at least 15 weeks in a calendar year were in 2001, 2003 and 2004. Prior to the last decade, investor bullishness was sometimes met with a big sell-off. For example, investors were roughly 60% bullish in August and September 1987, just weeks ahead of the October 19, 1987 Black Monday crash, when the Dow fell more than 500 points.

Investors once again turned extremely bullish again for a six-week span in the spring of 1991, and were rewarded with decent +10% gains in the S&P 500 for the next year. For the most part, investors wouldn’t be so bullish again until late 1999, just months before the market topped out in March, 2000. Even as the market tumbled throughout that year, investors remained very bullish, with the sentiment reading above 55% for 17 weeks during the course of the year. That bullishness in the face of a sharply falling market is the major reason why many individual investors sought to steer clear of the stock market for many years after that.

Yet the bullish readings aren’t always a harbinger of doom. In the second half of 2003 and throughout 2004, the AAII sentiment index would be at its highest levels for the whole decade. The sentiment reached an all-time record for bullishness with a reading of 71.4% in June, 2003. Those bulls made some nice money: the S&P 500 was up +30% three years later.

Action to Take –> While investor bearishness is a clear-cut buy signal, investor bullishness is not obviously so. The Black Monday crash in 1987 and the Nasdaq meltdown in 2000 came at a time of extreme euphoria. Yet a rebound in optimism in 2003 and 2004 was met with a better fate.

Investors are likely bullish now for a pair of reasons. First, they see recent market gains, and as always, want to join the party after it’s been underway for awhile. That’s not a good reason to be bullish. Second, just-released consumer confidence data showed a surprising uptick, a notion confirmed by better-than-expected retail sales in October. Rising consumer confidence and retail spending are solid reasons for turning bullish.

Even as you keep an eye out for fresh stock ideas with upside, you may want to take market neutral approaches, such as with a pair trade. [Read my recent article about pair trading here.]