Investor Psychology

Tap Into Market Sentiment Before Investing

Find out what the herd thinks, then head in the other direction.

In a story that may be apocryphal, businessman, investor and Kennedy clan patriarch Joseph Kennedy Sr. sold all his stocks before the 1929 market crash when a shoeshine boy gave him a stock tip. If even shoeshine boys are buying stocks, Kennedy reasoned, enthusiasm for stocks must be at the peak.

That makes sense. At major stock market peaks, most people are bullish. At major bottoms, most people are bearish. Sentiment indicators try to figure out just how bullish the Wall Street herd is so that savvy investors can do the opposite.

The trick with following sentiment indicators is that you must look for maximum bullishness and bearishness. It’s not enough to say, “My neighbor is buying stock in Amazon, so I’m going to sell mine,” even if you think he’s a clod. A better signal would be, “My neighbor is selling his house to buy Amazon, so I’m going to sell my shares.” But that doesn’t happen very often.

One popular sentiment indicator is the American Association of Individual Investors’ weekly survey. The venerable investors’ organization simply asks members whether they are bullish, neutral or bearish. As of mid July, according to the survey, 33.6% of investors were bullish, 38.9% were neutral, and 27.5% were bearish.

Topsy-turvy. In the upside-down world of sentiment indicators, an extremely high bullish response is a sell signal, and an extremely high bearish response is a buy signal. In this case, current sentiment indicators are telling us nothing particularly useful, except for the fact that AAII member investors are all over the map.

And that’s not enough to take action. Sentiment indicators work best at extremes, and we are nowhere near extremes. As a rule of thumb, a bullish reading above 48% is a worrisome amount of bullishness, and 40% is an amount of bearishness that should pique your interest. (People tend to be optimistic.)

Those levels aren’t foolproof. Periods of great bullishness can also be great times to invest. In the week of June 19, 1997, for example, AAII’s survey hit a seemingly worrisome bullish level of 59%. A year later, Standard & Poor’s 500-stock index was up 26%. Bullish sentiment didn’t peak until the week of January 6, 2000, when it hit a high of 75% and an epic bear market began.

Other sentiment indicators include the Advisors’ Sentiment Report from research service Investors Intelligence. The weekly poll measures sentiment among professional advisers. Currently, the ratio of bulls to bears is 3.10; a reading above 3 is cautionary, while under 1 is bullish.

Jim Stack, president of InvesTech Research, thinks that the University of Michigan’s Consumer Confidence survey is probably a better sentiment indicator. “Consumer spending is two-thirds of gross domestic product, and where consumer sentiment goes, spending follows,” he says.

The University of Michigan has three indexes of consumer confidence. The most important one tracks expectations. Extremely low consumer expectations—an index reading below 65—marked market bottoms in 1982 and 2009. A euphoric reading of 117.7 ushered in the 2000–02 bear market, and a moderately high reading of 77.9 preceded the 2007–09 bear. Current level: 89.3.

Because sentiment can be so volatile and unpredictable, it falls into the category of indicators that are worth watching but not definitive. If you’re investing when sentiment is high, you should probably limit your short-term expectations. If you’re buying when sentiment is low, remember that it can always get lower. And unless you’re a Joseph Kennedy, don’t take your investment cues from the person who shines your shoes.

Most Popular

Where's My Stimulus Check? Use the IRS's "Get My Payment" Portal to Get an Answer
Coronavirus and Your Money

Where's My Stimulus Check? Use the IRS's "Get My Payment" Portal to Get an Answer

The IRS has an online tool that lets you track the status of your stimulus checks.
February 19, 2021
Want More Tax-Free Retirement Income? One Man’s Whole Life Decision
life insurance

Want More Tax-Free Retirement Income? One Man’s Whole Life Decision

Whole life insurance might not be something that’s on your retirement planning radar, but for this client, here’s how it served his need to control ta…
February 23, 2021
The Current Plan for $1,400 Checks
Coronavirus and Your Money

The Current Plan for $1,400 Checks

Here's what you need to know about the stimulus check plan currently being considered in Congress for President Biden's COVID-relief package.
February 18, 2021

Recommended

Bonds: 10 Things You Need to Know
Investing for Income

Bonds: 10 Things You Need to Know

Bonds can be more complex than stocks, but it's not hard to become a knowledgeable fixed-income investor.
July 22, 2020
2 Top-Tier T. Rowe Price Mutual Funds
mutual funds

2 Top-Tier T. Rowe Price Mutual Funds

T. Rowe Price's mutual funds typically stand out among their peers, but these two selections provide elite equity and bond exposure for this point in …
February 24, 2021
How Green Are Your Bonds?
Becoming an Investor

How Green Are Your Bonds?

Fixed-income investors can make an environmental impact.
February 23, 2021
Warren Buffett Stocks Ranked: The Berkshire Hathaway Portfolio
stocks

Warren Buffett Stocks Ranked: The Berkshire Hathaway Portfolio

The Berkshire Hathaway portfolio is a diverse set of blue chips and, increasingly, lesser-known growth bets. Here's a look at every stock picked by Wa…
February 17, 2021