Investor sentiment has improved dramatically during the current bull market. Indeed, the Volatility Index (VIX), which measures investor sentiment levels, has fallen by around 70% between March 2020 and today despite ongoing global geopolitical uncertainty.
Since a higher figure suggests greater fear among investors, the VIX’s decline indicates many investors may be expecting further gains for the stock market following its doubling in just under two years.
Bull market end
Clearly, such investors may be correct in the short run. The stock market could continue to generate further positive returns based on factors such as accommodative monetary and fiscal policies, as well as an upbeat long-term economic outlook.
However, the stock market’s track record suggests the current bull run will ultimately end. The stock market has never delivered uninterrupted gains. It could be thrust into the next bear market by a variety of economic, political or other factors that are impossible to accurately predict, or quantify, in advance.
Ignoring other investors
As such, it may be prudent to ignore the views of other investors. They may have been proven correct so far, in terms of the bull market continuing. But in many cases, the same investors are likely to have believed the March 2020 crash would have been more severe and long-lasting than it proved to be.
Indeed, the track record of the investment "crowd" in predicting stock market movements has been relatively poor. In many cases, they rely on positive or negative emotions that are largely influenced by recent stock market movements to determine whether they are upbeat or downbeat about the stock market’s future prospects.
Baupost founder Seth Klarman (Trades, Portfolio) has previously discussed the investment community’s inability to accurately forecast stock market movements. He once said, "Over the long run, the crowd is always wrong."
A fundamental-led approach
It may be prudent to rely on fundamentals, instead of listening to the views of other investors, when deciding whether to buy, sell or hold stocks. Facts and figures, including company valuations relative to their historic averages and compared to sector peers, are likely to provide greater insight into the appeal of specific stocks in any market conditions.
Meanwhile, the size of the margin of safety on offer for specific stocks provides a guide to its risk-reward ratio. In the current investing environment, investors may determine that stock valuations are excessive. This may mean they sell holdings and hold cash instead of replacing them with better value stocks.
This strategy clearly requires a significant amount of patience. However, it could allow investors to purchase shares when they trade at lower prices in future and the investment herd is more pessimistic about the stock market’s outlook. History suggests they will likely be wrong about that, too, since the stock market has a strong track record of recovery that allows investors who step away from the crowd to take advantage of the market cycle.
