Piper Jaffray’s November 2016 issue of The Informed Investor included some great insight on investor sentiment. In short, we’ve reached bearish sentiment levels that, from a contrarian standpoint, suggests a positive outlook for equities:
The AAII Investor Sentiment survey measures the percentage of individual investors who are bullish, bearish and neutral on the stock market for the next six months. Of particular interest is the bullish percent number that is a solid contrarian indicator and often shows investors’ complacency/fear at important turning points in the market.
From a historical perspective, the lower decile (bottom 10% readings) of the Bullish % numbers resides at 26%. For the week ending November 2, 2016, the sentiment survey recorded a bullish % reading of 23.6%, which falls in the bottom decile of all observed values since July 1987 (as shown in the table right below). From a contrarian perspective, the data suggests a positive bias and that the path of least resistance is likely higher.
From a performance perspective, we went back in history (1987-present) and calculated average and median market returns after such low readings were observed. We note that the SPX index has been higher over the following 13- and 26-week periods, 74% and 81% of the time respectively.
Additionally, the SPX has recorded positive average returns of 7.7%, six months after weak readings of the Bullish % numbers were observed.
Perhaps you are scratching your head as to how this can happen when markets are so close to all-time highs. A couple guesses as to why this can happen. First, the election causes politicians to focus on the things that are going wrong (and how they are going to fix them!). The constant focus on the negative has the effect of, not surprisingly, causing people to overlook what may be going right. Second, the market has been flatish on a year-over-basis. When investors don’t get their expected 7-9 percent a year their mood drops (even if we’re not far from all-time highs).
Contrarian indicators such as this work best at the extremes and recent readings in the bottom decile suggest that the coming weeks and months may very well surprise to the upside.
Past performance is no guarantee of future returns. There may be times where all investments and strategies are unfavorable and depreciate in value.