- The August sell-off in the stock market has flipped investors from bullish to bearish.
- Various sentiment indicators have flipped negative, signaling that investors are still worried about a broader stock market decline.
- But the rise in bearish investors is actually a contrarian signal that suggests the bull market has room to run.
There's been a lot of whiplash in the stock market over the past month, with the Dow Jones Industrial Average going from its longest winning streak since 1987 in mid-July to a near 5% sell-off in the month of August.
That whiplash has hit investor sentiment, which has declined considerably in a short period of time. Investors were overly bullish heading into August as the S&P 500 continued its impressive year-to-date rally, according to various sentiment indicators, but the upbeat sentiment soured quickly as stocks kept falling.
The magnitude of the decrease in bullishness among investors is striking, especially when you consider the S&P 500 is down just a few percentage points from its recent 52-week high. That's table stakes in the stock market and is typically viewed as "profit taking" or "healthy consolidation of the market's recent gains."
Besides, stocks can't go up all the time. A few down weeks is normal.
The ping-ponging in investor sentiment readings is a bullish contrarian indicator, as it suggests not many investors have fully bought into the idea that a new bull market started earlier this year. And the stock market loves to prove its skeptics wrong as it often climbs a wall of worry.
And the sentiment indicators suggest there's a lot of worry out there.
CNN's Fear and Greed Index has fallen back into "Neutral" territory after being in "Extreme Greed" territory just one month ago.
The weekly AAII Investor Sentiment Survey has seen a marked decline in bullish responses from investors. In the most recent survey, only 32.3% of respondents had a bullish outlook for the stock market, which is below the historical average of 37.5%, and is considerably below the 49.0% reading seen at the start of the month.
Finally, the NAAIM Exposure Index, which tracks equity exposure among active investment managers, has plunged in the month of August. The index peaked at just above 100 in late July. The most recent reading has plunged to 34.6, representing the lowest level for the index so far this year.
The sharp decline in sentiment suggests that investors are more worried about getting trapped in another bear market decline than they are missing out on the next bull market rally. And while a further decline is still possible, any upside surprise in the economy or surprise dovish comments from the Fed could have a meaningful impact on stock prices as investors look for the all-clear to jump back into stocks.