Sentiment Indicator Flashes RED!

I wrote a post December 26, 2013 whose title was a famous Mark Twain quote, "History doesn't repeat itself, but it does rhyme!"  I discussed how, as a contrarian investor, I find extremes in investors' bullishness and bearishness to be calls to action--selling when a bullish extreme occurs  and buying when a bearish one is reached.  In short,  I view sentiment as a contrary indicator.

The sentiment indicator I have followed for decades is the weekly Investors Intelligence Sentiment Index Survey ("II").  If the percentage of bullish investors reaches 60% or more and the percentage of bearish investors 20% or less, that's a call to reduce my risk exposure to equities.

In that post I discussed how this call to action occurred five times during the last 25 years, and the average change in the Standard and Poor's 500 Index ("the Index") one year later was a MINUS 2.6% compared to average appreciation per year of 6% to 7% during that period.  On the surface, this relative performance is outstanding!  However, it is due primarily to having nailed the 2007 top in that bull market, from which there occurred a 39% drop in the Index during the ensuing year.  The other four observations were false positives, albeit three led to subpar appreciations during the following year, but one was a glaring error with an above average appreciation of 12.4%.

At that time, I reduced my exposure to equities from 42% of financial assets to my core level of 30% due to that extreme in bullishness.  In hindsight, that was a mistake! The Index appreciated 14% during the following year! So that was another glaring false positive.  Still the average appreciation for the six observations during the last 28 years is still only a  plus 0.2% a year.  One might argue that we could experience another half dozen consecutive false positives and still the overall performance would be good.

The latest II reading is 60.2% bulls and 18.4% bears.  Despite evidence that this sentiment indicator seems to be losing its predictive value,  I did rebalance again back to my 30% core equity exposure.  This is in addition to my rebalancing a few  weeks ago when the Shiller CAPE ratio reached 28. So now both valuation and sentiment indicators are flashing RED!