Markets

As Stocks Plunge, Sentiment Survey Sends a Buy Signal

By Conrad Aenlle

Updated on: August 4, 2011 / 1:27 PM EDT / MoneyWatch

Stocks dropped about 3 percent Thursday morning in what could be called a "Seinfeld plunge." Wall Streeters use the term "Seinfeld rally" to describe a rally about nothing, and the panicky decline that's underway seems to be the same thing in reverse.

There was no big negative number released on Thursday, leaving some media outlets to emphasize "growth fears" to explain the plunge rather than any concrete development. Actually there have been plenty of concrete developments in the last few weeks, such as economic output coming in below expectations; peripheral Europe racing toward insolvency; the sordid debate in Washington that produced a tepid agreement to reduce the growth of the fiscal deficit. Investors apparently are recognizing them now after having ignored them for days or weeks.

Some Wall Street firms issued notes to their clients Thursday morning speculating on a double dip into recession. When they did this before, it was more like an academic exercise, wondering if such a thing could happen and concluding that it could but was unlikely to. This time around the strategists are asking if the economy actually is heading toward another recession or had even entered one already.

Small investors may be asking the same thing, based on the latest sentiment survey of the American Association of Individual Investors. Bearishness in the survey, released Thursday and covering the five trading days through Wednesday, soared to 49.9 percent from 31.4 percent the week before, with just 27.2 percent bulls.

Card-carrying contrarians believe that a preponderance of opinion in one direction often heralds a market move the other way, and the AAII survey provides ample support of that view. The last time bearishness exceeded the present level was July 8, 2010, when it stood at 57.1 percent. That was almost precisely the post-flash crash low, from which the Standard & Poor's 500-stock index rose more than 30 percent in 10 months. Bearishness approached 50 percent twice during that rally, and each time it was near the absolute low of a dip that fueled the next leg of the advance.

Could it be different this time? Of course. It's also possible that high bearish readings and lower stock prices will continue for several weeks, as they did in late 2008 and early 2009. But such a stark increase in bearishness in one week, nearly 20 percentage points, is almost unheard of in the survey - it hasn't happened at least since the market top in 2007 - so while the investing backdrop seems a lot riskier, this could be a better time to buy than sell.