Stock Market Sentiment Review

November 19, 2013

I’m still getting back into the swing of things after having the flu most of last week.  In the midst of my stock market reading, I was struck by an article over the weekend from Abnormal Returns, a blog you should be reading, if you aren’t already.  The editor had a selection of the blog posts that were most heavily trafficked from the prior week.  Without further ado:

  • Chilling signs of a market top.  (The Reformed Broker)
  • Ray Dalio thinks you shouldn’t bother trying to generate alpha.  (The Tell)
  • Ten laws of stock market bubbles.  (Doug Kass)
  • How to teach yourself to focus.  (The Kirk Report)
  • Are we in a bubble?  (Crossing Wall Street)
  • Josh Brown, “If the entities in control of trillions of dollars all want asset prices to be higher at the same time, what the hell else should you be positioning for?”  (The Reformed Broker)
  • Guess what stock has added the most points to the S&P 500 this year? (Businessweek)
  • Everything you need to know about stock market crashes.  (The Reformed Broker)
  • Jim O’Neil is swapping BRICs for MINTs.  (Bloomberg)
  • How to survive a market crash.  (Your Wealth Effect)


I count five of the top ten on the topic of market tops/bubbles/crashes!

Markets tend to top out when investors are feeling euphoric, not when they are tremendously concerned about the downside.  In my opinion, investors are still quite nervous—and fairly far from euphoric right now.

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Saving Investors From Themselves

June 28, 2013

Jason Zweig has written one of the best personal finance columns for years, The Intelligent Investor for the Wall Street Journal.  Today he topped it with a piece that describes his vision of personal finance writing.  He describes his job as saving investors from themselves.  It is a must read, but I’ll give you a couple of excerpts here.

I was once asked, at a journalism conference, how I defined my job. I said: My job is to write the exact same thing between 50 and 100 times a year in such a way that neither my editors nor my readers will ever think I am repeating myself.

That’s because good advice rarely changes, while markets change constantly. The temptation to pander is almost irresistible. And while people need good advice, what they want is advice that sounds good.

The advice that sounds the best in the short run is always the most dangerous in the long run. Everyone wants the secret, the key, the roadmap to the primrose path that leads to El Dorado: the magical low-risk, high-return investment that can double your money in no time. Everyone wants to chase the returns of whatever has been hottest and to shun whatever has gone cold. Most financial journalism, like most of Wall Street itself, is dedicated to a basic principle of marketing: When the ducks quack, feed ‘em.

In practice, for most of the media, that requires telling people to buy Internet stocks in 1999 and early 2000; explaining, in 2005 and 2006, how to “flip” houses; in 2008 and 2009, it meant telling people to dump their stocks and even to buy “leveraged inverse” exchange-traded funds that made explosively risky bets against stocks; and ever since 2008, it has meant touting bonds and the “safety trade” like high-dividend-paying stocks and so-called minimum-volatility stocks.

It’s no wonder that, as brilliant research by the psychologist Paul Andreassen showed many years ago, people who receive frequent news updates on their investments earn lower returns than those who get no news. It’s also no wonder that the media has ignored those findings. Not many people care to admit that they spend their careers being part of the problem instead of trying to be part of the solution.

My job, as I see it, is to learn from other people’s mistakes and from my own. Above all, it means trying to save people from themselves. As the founder of security analysis, Benjamin Graham, wrote in The Intelligent Investor in 1949: “The investor’s chief problem – and even his worst enemy – is likely to be himself.”


From financial history and from my own experience, I long ago concluded that regression to the mean is the most powerful law in financial physics: Periods of above-average performance are inevitably followed by below-average returns, and bad times inevitably set the stage for surprisingly good performance.

But humans perceive reality in short bursts and streaks, making a long-term perspective almost impossible to sustain – and making most people prone to believing that every blip is the beginning of a durable opportunity.


But this time is never different. History always rhymes. Human nature never changes. You should always become more skeptical of any investment that has recently soared in price, and you should always become more enthusiastic about any asset that has recently fallen in price. That’s what it means to be an investor.

Simply brilliant.  Unless you write a lot, it seems deceptively easy to write this well and clearly.  It is not.  More important, his message that many investment problems are actually investor behavior problems is very true—and has been true forever.

To me, one of the chief advantages of technical analysis is that it recognizes that human nature never changes and that, as a result, behavior patterns recur again and again.  Investors predictably panic when market indicators get deeply oversold, just when they should consider buying.  Investors predictably want to pile into a stock that has been a huge long-term winner when it breaks a long-term uptrend line—because “it’s a bargain”—just when they might want to think about selling.  Responding deliberately at these junctures doesn’t usually require the harrowing activity level that CNBC commentators seem to believe is necessary, but can be quite effective nonetheless.  Technical indicators and sentiment surveys often show these turning points very clearly, but as Mr. Zweig describes elsewhere in the article, the financial universe is arranged to deceive us—or at least to tempt us to deceive ourselves.

Investing is one of the many fields where less really is more.

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The Emotional Roller Coaster

June 6, 2013

From Josh Brown at The Reformed Broker, a nice picture of investor emotions as they ride the market roller coaster.  All credit to Blackrock, who came up with this funny/sad/true graphic.

Blackrock’s emotional roller coaster

(click on image to enlarge)

One of the important roles of a financial advisor, I think, is to keep clients from jumping out of the roller coaster when it is particularly scary.  At an amusement park, when people are faced with tangible physical harm, jumping does not seem like a very good idea to them—but investors are tempted to jump out of the market roller coaster all the time.

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Raging Bull Market

October 18, 2012

I saw an article on CNBC that discussed the opinion of Citigroup strategist Tobias Levkovich.  Here’s an excerpt of his thinking on a bull market:

Tobias Levkovich, Citigroup’s U.S. strategist, is expecting the market to enter a ‘raging bull’ market next year.

While he continues to stick with his 2013 year-end target on the S&P 500 of 1,615, that would take the index above the prior peak of 1,558 reached in 2007.

Is this valid?  I have no idea.  However, I am getting pretty sick of reading bearish forecasts, so I like the way Mr. Levkovich thinks!

In truth, things are never usually as bad or as good as people forecast.  Given the pervasive gloom surrounding equity markets for the last several years, a bull market is not out of the question.  The stock market often does whatever is required to make the most people wrong, and a bull market would certainly catch a lot of investors flat-footed.


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Stock Market Perception vs. Reality

September 21, 2012

It’s no secret that investors have had a fairly negative outlook toward the stock market lately.  Their negative perception shows up both in flow of funds data and in our own advisor survey of investor sentiment.

One possible—and shocking—reason for the negative sentiment may be that the public thinks the stock market has been going down!

Investment News profiled recent research done by Franklin Templeton Funds.  Here is the appropriate clip, which is just stunning to me:

One surprising finding shows that investors are likely so consumed by the negative economic news, including high unemployment and the weak housing market, that they haven’t even noticed the strength of the stock market.

For example, when 1,000 investors were asked whether they thought the S&P was up or down during each of the past three years, 66% thought it was down in 2009, 48% thought it was down in 2010, and 53% thought it was down last year.

In fact, the S&P gained 26.5% in 2009, 15.1% in 2010, and 2.1% last year.

That blows me away.  I have never seen a clearer case of the distinction between perception and reality.  This data shows clearly that many investors act on their perceptions—that the market has been declining for years—not the reality, which has been a choppy but steadily rising market.

The stock market is ahead again year-to-date and money is continuing to flow out of equity mutual funds.  I understand that the market is scary sometimes and difficult always, but really?  It amazes me that so many investors think the stock market has been dropping when it has actually been going up.  Of course, perhaps investors’ aggregate investment decisions are more understandable when it becomes clear that only a minority of them are in touch with reality!

Advisors obviously have a lot of work to do with anxious clients.  The stock market historically has been one of the best growth vehicles for investors, but it won’t do them any good if they choose to stay away.  Some of the investor anxiety might be lessened if advisors stick with a systematic investment process using relative strength—and least that way, the client is assured that money will only be moved toward the strongest assets.  If stocks really do have a long bear market, as is the current perception, clients may be somewhat shielded from it.

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Investor Sentiment: July Edition

September 12, 2012

Why, you may ask, am I writing about investor sentiment from July now that it is mid-September?  I think it’s often a useful exercise to look back at the primary sources—the historical data—as my US history teacher used to point out.  We all have a way of mis-remembering history.  We modify it to fit the present, so that whatever happened seems inevitable.  The future, of course, is always uncertain.

Investor sentiment is a peculiar form of history because it generally works in contrary fashion.  Studies show that when investors are most bullish, the market tends to go down.  And when investors are bearish, the market perversely tends to go up.

July was just such a period.  Consider, for example, a CNBC article on the weekly sentiment poll conducted by the American Association of Individual Investors (AAII):

Main Street bulls are fast becoming an endangered species.

Despite the fact that the broad U.S. stock market is up 8.4 percent in 2012, only 22 percent of mom-and-pop investors said they were bullish, the American Association of Individual Investors found in its latest weekly poll.

That’s the lowest sentiment reading since summer 2010, when markets were careening lower in the face of the first post-recession global growth scare and the emergence of Europe’s debt crisis.

But to drive home just how pessimistic Main Street investors have become in the face of a weak U.S. economy, slowing growth in China and continued uncertainty about Europe’s financial crisis, consider that:

• Bullishness now is more depressed than in the fall of 2008, when Wall Street titan Lehman Bros. declared bankruptcy, thrusting the financial crisis into a more dangerous phase.

• The percentage of bulls today is barely above the 18.9 percent on March 5, 2009, just four days before the bottom of the worst stock slide since the Great Depression.

I think it’s fair to say that investor sentiment was pretty negative in July.

So what’s happened since then?  All of the bearish investors were not able to make the market go down.  Instead, it has risen—the S&P 500 level has gone from about 1350 to 1435!

In fact, this is a typical outcome:

But all the negativity may turn out to be a positive: History shows that super-low sentiment readings tend to act as a contrarian signal. In other words, when everyone is worried, stocks tend to rally.

In fact, according to Bespoke, going back to November 2009, U.S. stocks have posted average gains of 5 percent — with gains 100 percent of the time — in the month after AAII’s sentiment poll showed bullish sentiment readings below 25 percent.

I added the bold to emphasize the cost of bad investor behavior.  What if you had exited the market in July because you were bearish?  About half of the gains year-to-date have occurred since then.  Things always seem darkest before the dawn, but it’s important to resist bailing out when frightened.  Better to structure your portfolio so that you can sit tight regardless of the current situation—or to cut back when things seem to be going exceptionally well.  It’s tough to get the upside exit right, but it’s relatively easier to flag time periods marked by poor sentiment that are likely to be bad times to get out.  If you stay the course, it could make a big positive difference to your returns.

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Investor Sentiment

July 6, 2012

Rick Ferri has an interesting blog piece that was brought to my attention through Abnormal Returns.  (Maybe I can stir up a little controversy for a blog you should be reading every day.)  In it, Mr. Ferri suggests that investor sentiment surveys don’t work because they are equal-weighted.  He contends that only the opinion of large investors matters and says to follow the money.

He says explicitly, in the case of bonds, that large investors were right and predicted falling interest rates—and he implies that large investors are typically right, and that by following the money you can be right as well.  (In a recent well-publicized case, in fact, the largest private bond investor in the world, Bill Gross of PIMCO, exited all of his Treasury positions and called for higher rates.  He got that call wrong.)

Rick Ferri has many interesting and valuable ideas, but I think he is off base on this one.  Lot of studies of institutional big-money investors show they get things wrong just as often as retail investors.  If Mr. Ferri were correct in his assertion, studies would show that institutions typically outperform and individuals typically underperform.  That’s not what the data show at all.  Institutions aren’t that different from retail investors.

Investor sentiment surveys work very well–it’s just that they work in a contrary fashion.  The reason they work in a contrary fashion, I believe, is a psychological phenomenon known as cognitive dissonance.  We’ve written about this before.

Cognitive dissonance leads to the desire to reconcile your actions and beliefs.  The naive view is that we all have certain firmly-held core beliefs and we endeavor to act appropriately, so that our beliefs and actions are aligned.  Lots of psychological research shows otherwise.  In fact, we make decisions (act) and then construct our beliefs so as to rationalize those decisions!

Think about how this might operate in the financial markets.  First we buy (sell), and then we report ourselves in the survey as bullish (bearish).  We’re just trying to reconcile our beliefs with our actions.  “Of course I’m bullish–I’m long” is the train of thought.  How uncomfortable would a CNBC interview get if the investor was known to be short, but had a wildly bullish market outlook?  Cognitive dissonance predicts that people will talk their book.  I think that’s a pretty good description with what happens with all of us.

Contrary interpretation works with investor sentiment at the extremes.  At one extreme, there are no bulls to be found.  Why?  Because they’ve already sold and are now reporting themselves as bearish.  When the last investor sells, the selling pressure is gone and there is only one direction for the market to go—up.  Colby and Meyer’s book The Encyclopedia of Technical Market Indicators has statistics on the Investors Intelligence sentiment survey that are quite remarkable.

In short, individuals do not have an insurmountable gap relative to investment committees at big-money firms.  Intelligent decision-making may be rare in both places, but thoughtful and disciplined investors have an opportunity to perform well if they make good choices.  It is not the size of the investor, but rather their mindset, that makes the difference.

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More on the Death of Equities

July 3, 2012

This is getting serious!  We’ve written about this “death of equities” theme before.  The strategist at Bank of America Merrill Lynch rolled out some interesting data today regarding the “death of equities.”  Despite generally rising prices for the past three years, stocks have gotten very little respect—and now there’s this from an article at CNBC:

For a group notorious for its irrational exuberance at the very worst times, Wall Street strategists have taken a decidedly bearish tack as of late.

In fact, their current consensus allocation to stocks versus bonds and other asset classes makes the group the most bearish since 1997, according to data compiled by Bank of America Merrill Lynch.

This average equity allocation at 49.3 percent is “the first time below 50 in nearly 15 years, suggesting that sell side strategists are now more bearish on equities than they were at any point during the collapse of the tech bubble or the recent financial crisis,” wrote Savita Subramanian, chief U.S. equity and quant strategist for the firm, in a note entitled, “Wall Street Proclaims the Death of Equities.”

I put the fun part in bold.  This is the most bearish that strategists have been for 15 years!  The best thing about their bearishness, though, is the implication from contrary opinion.

Bank of America’s Subramanian actually has the data that backs up this contrarian view. According to her report, when the indicator has hit levels this low over the last 27 years, total returns for the market have been positive 100 percent of the time, with a median return of more than 30 percent.

It makes perfect sense, given what we know about investor sentiment and subsequent returns.  Who knows what will happen this time around—but those odds seem pretty good for stock investors.

Have Equities Kicked the Bucket?


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Another Take on Market Valuation

June 7, 2012

Not too long ago, we showed a market fair value estimate done by the analysts at Morningstar.  Another take on it comes from Kelley Wright at Investment Quality Trends.  Their valuation method is based on where dividend yields are for individual companies, based on the typical range for that particular company.  What’s nice about this particular measure of valuation is that it has been statistically tested.  A couple of excerpts from the story by Mark Hulbert at Marketwatch:

Wright classifies each of the stocks that make the grade into four categories according to how its current dividend yield compares to the historical range of that stock’s yield.

The “Undervalued” category contains those stocks with yields at or close to the high end of their respective ranges, while the “Overvalued” category contains stocks with relatively low yields.

The statistic that is most relevant to market timers, I found upon analyzing the data, is the percentage of stocks that make it into this “Overvalued” category. At the 95% confidence level that statisticians often use to determine if a correlation is genuine, this Overvalued percentage is inversely related to the stock market’s return over the next several years.

That is, a high percentage of Overvalued stocks is a bad omen, while a low percentage is a good one.

Currently, Wright’s Overvalued category contains just 35 of the 254 stocks in his dataset, or 13.8% of the total.

That is well below the five-decade average of 21%. In fact, it is lower than 69% of comparable readings back to the mid 1960s.

My finding suggests that the stock market is poised to produce above-average returns over the next couple of years.

It’s interesting to me that sentiment is so negative toward equities that stock funds have been seeing outflows, despite a number of measures suggesting that stocks may have reasonable returns going forward.

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