Others fear my greed! Emotional contrarian indication September is a golden opportunity to layout US stocks

After experiencing volatility at the beginning of the second consecutive month, the US stock market rebounded again, mainly due to the rebound of some large technology stocks and the decline in US bond yields.

The S&P 500 Index (SPX) has risen by 3.46% in the past four trading days, with NVIDIA (NVDA) surging by 15.9% during the same period, bringing the S&P 500 to within 1.3% of its mid-July record high.

Market observers and data analysts at Bespoke Investment believe that all of this indicates the benefits of investors remaining cautious of contrarian market signals. In a new report, they pointed out that as bullish sentiment declined, the US stock market saw the latest round of rebound.

Bespoke Investment analyzed the latest report from the American Association of Individual Investors (AAII). AAII is a weekly sentiment survey that is considered more valuable as it has been running for over 35 years.

AAII Bullish Sentiment

Bespoke Investment noted that after exceeding 50% in recent weeks, the AAII bullish sentiment reading sharply dropped to 39.8% this week as respondents became more cautious.

Next, they looked at the 52-week rolling average of AAII bullish sentiment and stated, "This provides a smoother, longer-term perspective on sentiment readings."

The second chart shows that from the end of 2022 to the beginning of 2023, individual investors' sentiment was at its most pessimistic, which coincided with the brutal bear market about to transition to the current bull market.

52-Week Rolling Average of AAII Bullish Sentiment

Bespoke Investment said, "In hindsight, the most pessimistic sentiment is actually the most bullish time for investors, given how well the market has performed thereafter. This is why sentiment readings are considered contrarian indicators, as investors tend to be overly optimistic in rising markets and overly pessimistic in falling markets."

Furthermore, the following chart shows the monthly average historical difference between AAII bullish and bearish sentiment readings, where higher readings indicate investors have been more optimistic over the years, while lower readings indicate less optimism.

As we can see, the difference in September has historically been the smallest. Bespoke Investment stated, "Given that September has traditionally been the worst-performing month for the US stock market, this is not surprising, but it once again highlights the contrarian nature of investor sentiment." However, despite September being a tough month, it is followed by the historically strongest period - the fourth quarter.

Bespoke Investment summarized: "Considering the continuous rise of the US stock market over time, the weakness in September should be seen as an attractive opportunity to increase equity exposure, rather than a time to become more pessimistic."