Sentiment Is Slow to Change, Part II

Market sentiment is an important variable both for traders and investors. Simply put, if nearly everyone is bullish, who is left to buy? If there is a high level of bearish sentiment, asset allocations can shift to stocks both rapidly and dramatically.

Readers of "A Dash" know that we use different measures of sentiment for different time frames. We see sentiment as "sticky" or slow to change since those who have formed opinions are reluctant to accept the significance of new information. We described the entire process using the real-time trading of a sports event, attempting to help readers to escape the normal trading biases.

Application to Stocks

Gary D. Smith, who has an excellent multi-year record of finding profits, is quite willing to adjust his daily positions to reflect events. He graciously shares many of these viewpoints, and a lot of important market data, for anyone wise enough to follow his work. We repeat our strong recommendation to do so.

Gary reports on the most recent data from the American Association of Individual Investors as follows:

The AAII percentage of bulls fell to 30.4% this week from 45.8% the prior week. This reading is still at a depressed level. The AAII percentage of bears rose to 48.7% this week from 37.3% the prior week. This reading is still at an elevated level.

There is plenty of additional detail, including the 10-week averages that show the "sticky" behavior of this sentiment. The entire article is worth reading.

Gary adds additional information about other indicators. Here is the more comprehensive story:

Individual and professional investor pessimism towards U.S. stocks remains deep-seated and historical in nature. It is also noteworthy that short interest continues to soar to new record highs, corporate insiders continue to display downright giddy behavior, domestic mutual funds continue to see significant outflows, hedge funds remain net short, the equity put/call 20-day moving average recently hit an extreme, a massive mountain of money market cash on the sidelines continues to grow and according to Google Trends the use of the word “depression” in the news media has recently spiked over the last year. [check the useful links in the original article.] This is just some of the evidence of the current “U.S. negativity bubble."

A Typical Opposing View

Writing in his weekly column for Barron's, Alan Abelson states a typical opposing viewpoint:

No arguing that the various and sundry surveys of how investors feel about the market show they've been uniformly and emphatically negative. But our own sense is that the bearishness is a mile wide and an inch deep. That to judge by how they act rather than what they say, the investing multitudes have been champing at the bit to take the plunge...

Rejecting the traditional indicators, Abelson cites anecdotal evidence from the attendance at presentations by a bearish economist. A novel approach indeed!

Others making similar long reaches for an argument ask, "How can the market have bearish sentiment, when it is reaching new highs?" Market averages can and do fight sentiment -- all the way up (or down). This was the point of our out-of-the box illustration from sports.

Our Take

Investors should let evidence lead them to a conclusion, changing opinions when indicated. When one instead begins with the conclusion, it is always possible to find some new indicator that seems to confirm one's viewpoint.

Understanding the difference is crucial to investment and trading success. We agree both with Gary's evidence and his conclusion, "I still expect U.S. stocks to rise sharply from current levels later this year..."

Comments

[karchad]

I agree totally with this article. One only has to read the posts on SeekingAlpha to realize the extreme quantity and quality of the negative sentiment. Now, that doesn't always translate to immediate gain tomorrow. But it makes me, a long-term investor, very confident in the next few years. Another reason that I feel confident is, I am hearing non-investors talk about going into gold and commodities. I guess these are the same people who talked about tech in 1999 and real estate in 2005.