Tag Archives: summer

Investor sentiment indices such as the AAII have been extremely bearish since this summer, before the August downturn. Many analysts have pointed to this bearish sentiment as a contrarian, and therefore bullish, indicator. However, the bearish investors this summer were proven right in August, and they may well be proven right again in October. Sentiment surveys may no longer reflect the opinion of as substantial a portion of the market as they used to. Also, the spreading knowledge of technical analysis in recent years may have made average investors — lo and behold — smarter than they were in 2007-2008. Since this summer, well before the August downturn, a variety of measures of investor sentiment have given extremely bearish readings. Headlines appeared in July that investors are the most bearish that they’ve been in 15 years, and similar headlines still appear in September. And it is now typical for the articles about these bearish sentiment measures to point out that historically such sentiment readings have been a contrarian indicator: Extreme bullish sentiment has tended to indicate that a bull market has peaked and is about to decline, while extreme bearish sentiment has tended to indicate that a bear market has bottomed and is about to rally. Strangely, though, this year bearish sentiment exploded before the bull market even entered a correction. Some analysts still point to the sentiment now and use it as an argument that we are only in a correction, not a bear market, and that the bull market will soon resume its march higher. I doubt this very much. Rather, I argue, this year — for once — investor sentiment was and is on the money about the direction of the market. Investors were and are right to be bearish. So why is investor sentiment no longer a contrarian indicator in 2015? This is a very good question, so allow me to offer a couple plausible explanations. First, the individual investors whose sentiment is being measured in the surveys may not represent as substantial a portion of the market as they used to. Large institutional investors make up an even more dominant share of the market than they did 7 years ago or 15 years ago. Trading driven by computer algorithms is certainly a much bigger factor in the market than it ever was before. This summer, individual investors felt the fear before the technical indicators alerted the computer algorithms that something was wrong. Another factor in recent years is the flood of money from overseas that has been seeking out relative safety in the U.S. stock markets. Most of the sentiment indicators probably do not incorporate the opinions of overseas investors as much as those of American investors, so the surveys are likely overlooking relatively more bullish sentiment from overseas investors, who have been happy to buy U.S. stocks rather than Asian, European, or other stocks. Second, the spread of technical analysis itself may be a factor in the sentiment readings since August (most technical indicators turned negative slightly before the market downturn). Individual investors have far more access to the basic principles of technical analysis than they did 15 years ago or even 7 years ago. The technicals were flashing danger signs almost an entire year before the 2008 crash, but most investors were not aware of them or ignored them. Today there is far less ignorance or lack of awareness of such information among investors. Many more people now know how to read a simple chart of the price, the 50-day moving indicator, and the 200-day moving indicator of a stock or index. And even such simple charts give an accurate enough indication to tell individual investors to be bearish before the market has bottomed, rather than waiting until after the market has bottomed to suddenly panic. Moreover, the type of knowledgeable investor who understands technical analysis is precisely the type of investor who is also likely to be a member of the American Association of Individual Investors and reply to their sentiment survey. The investment newsletter advisors whose sentiments are measured in the Investors Intelligence survey are also more likely to follow the technical charts. I strongly suspect that newsletter advisors too have increased their knowledge of basic technical analysis a great deal in the past 7 years. On the other hand, the more passive “buy and hold” investors, and the people who simply put part of their 401k money in an S&P 500 index fund and never make any adjustments to it, are less likely to pay enough attention to turn bearish before the market completely crashes and they panic. Their sentiments are also less likely to be captured in investor sentiment surveys. In summary: The type of active investors whose opinions tend to be measured in sentiment surveys may well have gotten a lot smarter now than they were 7 years ago or 15 years ago! I dare say websites such as Seeking Alpha may have contributed to this increase in investor education. There is still a lot of dumb money out there, but at least there’s hopefully less of it, especially among investors such as those who read Seeking Alpha.