January 9, 2015, New York (HedgeCo.Net) Alcoa (AA) is set to report earnings after the closing bell on Monday, January 12 and that will kick off the next round of earnings season. Given the rally the market has experienced for the last few years and the increase in volatility over the last three or four months, this particular earnings season could be more important than usual.

With most sentiment indicators skewed toward the bullish camp heading into the earnings season, it would seem that expectations for earnings reports are rather optimistic. The American Association of Individual Investors (AAII) Sentiment Survey released on December 31 showed a bullish percentage of 51.7% while the bearish percentage came in at 19.3%.

Looking at these percentages in terms of a ratio, the ratio of bulls to bears is at 2.68. The ratio has been above 2.0 for each of the last two weeks and in eight of the last 10 weeks. The last time we saw a similar stretch of readings above 2.0 was at the end of 2004. If you recall, the market was extremely choppy in 2005 and the year was saved by positive returns in November and December. There was a period at the end of 2010 that had a number of weeks where the ratio was above 2.0 as well, but not to the extent we are seeing now or what we saw in 2004. At any rate, 2011 was also a tough, choppy market for stocks.

Another sentiment indicator that had been trending toward a more optimistic outlook up until Christmas is the CBOE Volatility Index (VIX). The VIX had dropped down to the 14 area after spiking during the one-week selloff in mid-December, but over the last few trading sessions it has jumped back above the 18 level.

Looking at the 18 level, you see how few days the indicator spent above that level in the first nine months of the year and then over the last three months it has jumped above 18 with ease. This reflects the increased volatility that was mentioned earlier.

With the sentiment reflecting a considerable amount of optimism and the market near all-time highs, it would seem investors have high expectations for the earnings season. In a previous article, we mentioned the high level on the Shiller P/E Ratio which adjusts the earnings in order to account for inflation. Even the regular P/E Ratio has crossed above 20 for the first time since January 2010. And you may recall that 2010 was a choppy market with all the gains coming in the fourth quarter.

Between the sentiment indicators and the two different P/E ratios registering relatively high readings, one has to wonder what impact the earnings season will have on the market. If it is a choppy market like we saw in 2010 or 2011, having a portfolio that is actively managed and uses hedging techniques may be a necessity. One option is to consider our new HedgeCoVest platform.

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