If you have read any of my postings here you know that I’m not a big fan of indicators that attempt to predict the market. I feel they are ambiguous and very difficult to use in a sensible investment process. However, I do think it’s fascinating to track the investor sentiment readings as a case study in investor psychology. As we know, they are typically used as a contrary indicator.
This was a recent headline from CNBC….
Bullish Sentiment Plummets to Credit Crisis Low
The number of individual investors who have a bullish outlook on the stock market for the next six months plunged to 21 percent, from 30 percent last week, according to a widely followed sentiment survey.
What's more, this is the lowest weekly reading from the American Association of Individual Investors since a March 2009 level of 19 percent, which occurred just before the S&P 500 collapsed to a 12-year low of 676.
Many of us remember what investor sentiment was like as the century came to a close. The sky was the limit for the stock market. The bookstore shelves were crowded with volumes about how to get rich with stocks. The average investor expected 20% plus in annualized returns from their portfolios. Here we are almost eleven years later and we are down anywhere from 30 to 50% from the highs – depending on what index you’re using. Interesting side note – the investment sections at your typical bookstore are much more scaled back and the shelves are filled with titles such as ‘Survive the Crash’ and ‘The Coming Depression’. I do believe that sentiment indicators can have some value as contra-indicators when markets reach extreme points. That is, when investors are overly bullish – be cautious. When investors are overly bearish – much of the risk has been taken out of the market. It is interesting and quite ironic that when investors the best is actually when investing risk is the highest.
So how can we make use of this indicator? Perhaps we can rename it the risk / reward indicator. To my earlier point, we bearish sentiment is at a peak – the excesses have been removed from the market’s risk / reward balance. I am constantly trying to explain that the market’s risk level is far lower today than it was back in those heady days. Does this mean that the market can’t go lower? - Absolutely not. But the odds are much more in your favor.
