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'Neutral' sentiment signals a big move

Earnings season rolls on and the market is liking what it hears. According to Reuters 70% of the S&P 500 (^GSPC) members reporting so far have beat analyst estimates. Even in the world of Wall Street where estimates are reliably sandbagged, broadly speaking earnings have been solid. At the very least the market seems to like what it hears, based on the Dow (^DJI) and S&P dancing with new all-time highs on a regular basis.

In the attached clip David Lefkowitz of UBS Wealth Management says he’s been impressed. “About 70% of companies are beating earnings and nearly that number are beating on sales as well so these are pretty high quality results,” Lefkowitz points out in the attached clip. ”What’s even more important is the bar wasn’t lowered as much as it normally is heading into earnings.”

Though the quant-jocks would claim otherwise, the truth is that valuation is as much a function of sentiment as trailing fundamentals. If growth rates are high and regarded as plausible just about any stock can seem cheap. That makes it impossible to completely divorce investor’s collective sentiment from the equation.

On that front it’s instructive to look at the American Association of Individual Investors weekly Sentiment Survey. It’s a noisy survey. Predictably the number of bulls and bears tends to fluctuate wildly. That’s why I watch the “Neutral” level for market tells. I first highlighted this in early May when the survey showed 28% Bulls, 29% Bears and 43% Neutral. That was the highest percentage of respondents with no official market opinion in a decade. (Note: Neutral peaked at 44% a week later).

As was the case on 3 of the last 4 times the Neutral read had spiked over 40%, stocks rallied sharply in the following weeks. The S&P 500 is up 6% and counting since the first week of May.

Thursday morning AAII showed 29.6% Bulls, 29.9% Bears and a whopping 40% Neutral. That doesn’t necessarily presage another big rally but at the very least it’s hard to make a compelling case for euphoric investors when more than two-thirds of investors polled are either bearish or apathetic about stocks.

Lefkowitz doesn’t much concern himself with such things. To him it’s about the earnings and on that front things look solid. “Valuations are fair to maybe slightly expensive but if PE stays constant and earnings grow about 9%, that’s the kind of return you can expect for stocks for the full year.”

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