The efficient market hypothesis assumes “rational expectations” but investors are anything but rational, especially at extremes. They may talk about buying low and selling high but when it comes down to it, if we examine their actual behavior they often do just the opposite.

With markets hitting new highs daily and volatility near historic lows, individual investors are just about as bullish on the future prospects of stocks as they’ve ever been.

The most recent sentiment poll released by AAII showed that 57.9% of participants are “bullish” on the stock market for the next six months. Going back to the inception of this weekly poll in 1987, this value is in the 95th percentile, meaning that only five percent of the time were investors more bullish than they are today.

This is of course in sharp contrast to the lack of bullishness exhibited just before the bear market low in March 2009, where only 18.9% of participants in the poll were “bullish” on stocks.

What does the current level of bullishness mean for the equity market going forward? If history is any guide, investors should at the very least be expecting below average returns over the next year. This is clearly illustrated in the table below which compares future returns for the S&P 500 when sentiment was at similar extremes to returns in all periods.

The last time we saw sentiment this extreme was in December 2010. Following this extreme was of course 2011, a flat year for equities in which there was a 20+% correction during the year (see chart below).

It remains to be seen if a similar scenario plays out or if individual investors will exhibit better market timing skills this time around. As I wrote earlier in the week, it is plausible that strong momentum and seasonality may trump this extreme overbullish sentiment into year-end, but 2015 is likely to be a more challenging environment.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.