From Tony Pallotta of Macro Story
Sentiment Surveys Or Margin Debt Who Is Smarter?
The one and only data point that has given the bears pause is the extremely bearish sentiment readings. As an example the AAII survey recorded its highest bullish view on December 21, 2010 at 63.3% bullish to 16.4% bearish whereas on June 15, 2011 those readings were 29.0% bullish to 42.8% bearish.
Bulls have argued this contrarian indicator says to buy stocks while bears have scratched their heads questioning why sentiment is so bearish with the VIX below 20 and equities only 7% off their multi year highs. Makes no real sense or does it?
Perhaps the best sentiment reading is the level of margin investors are using to place their bets. After all, margin means you are literally sitting at the poker table determined to beat the house while the sentiment survey has you sitting behind a keyboard answering questions. Who is more emotional and thus the one you want to fade? If you cannot answer this question it is because you are sitting at the poker table as well apparently.
Below is a chart of debit margin balances versus the five week moving average of the AAII bullish sentiment readings. Notice how bullish views peaked five months before margin levels peaked in 2007. Similarly bullish views peaked in December 2010 (the moving average peaked in February 2011) while margin levels continue to rise through April. Considering the May 1,370 high subsequent margin data when available may very well show May as the peak in margin debt.
There is at least one possible explanation for this divergence. As sellers move out of the market, this historically contrarian indicator entices leveraged longs to increase the use of margin thus supporting prices. A negative feedback loop is in fact created causing markets to resist selling pressure.