A recent survey by the American Association of Individual Investors shows a rise in stock market sentiment, climbing from 28.0% to 41.7%. This is the biggest jump since January and the highest level since hitting 45.0% on July 3rd, which matched a yearly peak. This increase isn’t a sell signal right away, but it is above the long-term average of 37.5%, a level not seen in seven weeks. Meanwhile, bearish sentiment remains notably high at 42.4%, well above the average of 31.0%.

Historical Bullish Sentiment

Historically, the highest bullish sentiment was 75% during the dot-com bubble peak in January 2000. In April 2021, bullish sentiment was at 56.9%, right before a market peak in December that same year. Another peak occurred in July 2024, with 52.7% bullishness, followed by a quick 9.7% correction. This decline slowed when the Federal Reserve hinted at a potential rate cut. It’s wise to keep an eye on this sentiment indicator, particularly if it goes above 50% or 55%, as those levels may suggest market volatility. With bullish sentiment experiencing its biggest weekly increase since January, we are now in uncertain territory, especially as the S&P 500 approaches 6,150. High optimism, now exceeding its long-term average, often leads to market pullbacks. A look back at the summer of 2024 shows how a sentiment peak was followed by a sharp drop.

Strategy for Portfolio Protection

This suggests it may be a good time to consider securing some portfolio protection before it becomes costly. The CBOE Volatility Index (VIX) is currently around 13.5, which is low historically and indicates market complacency. This means buying options is relatively inexpensive compared to times of market stress, when the VIX can rise above 20 or even 30. Looking at out-of-the-money put options on the SPX or QQQ for October or November could be a smart move. This offers a cost-effective way to hedge against a potential 5-10% downturn like we saw last year. The aim isn’t to predict a market top but to protect the portfolio against a likely dip. However, it’s essential to recognize the high bearish sentiment at 42.4%. The stark difference between bulls and bears suggests disagreement in the market, which can increase volatility. This situation makes strategies that profit from price swings, such as VIX calls or long straddles on volatile tech stocks, appealing. Unlike the 2024 pullback, which had clear signals for rate cuts, the current environment is trickier. The Federal Reserve is on pause, and the latest CPI report shows a slight inflation increase to 2.9%, making further intervention less likely. This economic uncertainty underscores the need for derivative hedges instead of assuming a quick “buy the dip” rebound. Create your live VT Markets account and start trading now.

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