This week I want to start with a look at sentiment. This is an indicator that shows how confident investors are. Sentiment has been leaning toward the bearish camp for months, according to the American Association of Individual Investors survey.

Source: AAII

Every week since 1987, AAII conducts a survey. There’s just one question in the survey — are you bullish, bearish, or neutral about the next six months? The results have been surprisingly useful.

I say “surprisingly” because it seems as if respondents could say one thing and do another; this is often seen in political polling where candidates the media say are flawed often do better in elections than in polls. That’s because respondents might be reluctant to admit they like flawed candidates even if they are willing to vote for that person.

The same problem would seem to be possible in this survey. Respondents seem like they would react to news. But that doesn’t seem to be the case.

Over time, extremes in the survey match up well with extremes in the price action. So when an extreme bearish reading is seen, we should expect a rally. That’s exactly what we saw earlier this month.

In the most recent survey, we have an extreme neutral reading. In the past, this has been the most reliable and most bullish signal in the AAII data. Neutral readings are bullish because they show a large number of investors are waiting for a reason to invest their money. This is a reading indicative of money on the sidelines and the movement of that movement should push prices up.

How I’m Trading Right Now

This signal is supported by indicators that tell me the worst of the recent decline appears to be over.

This can be seen in the next chart of SPDR S&P 500 ETF (NYSE: SPY). It shows that my Income Trader Volatility (ITV) indicator (red line) remains above its moving average (blue line) in the chart below. But the indicator is moving lower. This is similar to the pattern seen in October when SPY began a sharp rally.

For those who aren’t familiar with ITV, think of it as a volatility indicator (like the VIX), but for individual stocks and ETFs. As the indicator crosses below the moving average, it creates a “buy” signal.

My Profit Amplifier Momentum (PAM) indicator confirms my optimistic outlook as it is positioned to complete a bullish crossover and give a “buy” signal. PAM has rallied sharply along with price since reaching an oversold point in early December.

PAM is designed as a short-term indicator. It will turn bullish this week as long as SPY holds above Friday’s low of $466.51.

Seasonals are also bullish. My final chart shows SPY with its seasonal tend for the past 20 years. A bottom was expected last week and momentum indicates we most likely recorded the low for the month.

Closing Thoughts

Overall, my indicators are saying that it’s likely the Santa Claus rally is beginning. As I’ve noted the past couple weeks, December has closed higher 88% of the time in the first year of a Presidential administration.

If there is any additional selling, that should be considered to be a buying opportunity. However, I expect selling pressure to be light as buyers return to the market for the rest of the year.

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