It's Time to Buy into This Rally

I size up investor sentiment for a living. And I've learned the money is made at the "extremes."

When most investors are feeling invincible, it's often a sign to sell. The opposite is true as well... When the majority of investors are scared (which doesn't happen that often), it's usually a great time to buy stocks. 

If you're not familiar with what a sentiment "extreme" is, let me share one with you... 

The latest sentiment survey from the American Association of Individual Investors (AAII), showed a new all-time high in the percentage of individual investors who expect the market to continue to decline. Seventy percent of AAII members expect more erosion!

Since the survey's inception in 1987, only one other survey approached this level of pessimism. Sixty-seven percent of AAII members were bearish during the week of October 19, 1990, in the last "real" recession. That also happened to be the week the S&P 500 ended its decline for that cycle.

Today, we're seeing an extreme in sentiment – more people are negative on stocks than ever. It may mark the bottom again, just like it did in 1990.

We've been seeing other extremes, too. We've gone more than 40 straight days without more than 1% of NYSE issues recording a new 52-week high. We've gone 290 days without anything more than an 80-day rally. Corporate insiders are picking up their buying in a major way, nearing 30-year highs. I could name many more...

For example, the eight other times since 1928 that the S&P has closed at a 52-week low one day (like Monday), then closed above the five prior closes the next day (like Tuesday), stocks were higher a few weeks later every time... even during the worst of the 1930s.

So we have the setup now (extreme bearish sentiment) and the trigger (the price pattern) that has occurred with regularity at past major lows in stocks, with exceptionally few "false positives." This is the kind of situation we look for to establish trades with low downside and high upside.

I believe we're likely at the inflection point, where we'll see a multi-month bottom take hold. There should be significant upside potential with limited downside risk over the next one to three months. 

If the S&P drops below Monday's low of 666 within the next two weeks, especially for more than a day or two, then I will likely be wrong... But we're seeing the same general price pattern we have seen at previous inflection points in the market. When we have the combination of an extreme in sentiment and the kind of price patterns we've seen this week, it's time to expect higher prices.

Longtime readers know I'm a conservative guy. I don't stick my neck out too often. While we can never be certain, the risk versus the reward now looks pretty darn good!

All the best,

Jason Goepfert

Editor's note: With original commentary and easy-to-read charts, Jason gives some of the most thorough analysis of market sentiment you can find anywhere. 

If you're not familiar with the work he does over atwww.sentimenTrader.com, you really should check it out. Right now,DailyWealth readers can get a 30-day free trial... just type "dailywealth30" in the Detail box on the subscription page.