Investors who thought the stock market was a dreadful place last year have changed their opinion. Now they're excited about AI and have dubbed mega-cap growth stocks'magnificent'. It's called market top and star investor euphoria. Using investor feedback to identify key trends in the market is a challenging task. How will you choose between the bull and bear and how do you think you will be successful in the long term?
How investors are feeling about the market is measured by a variety of surveys conducted by various organizations. Pairing their findings with market returns data shows how predictive investor sentiment can be experienced in bull and bear markets.
One such survey is the American Association of Individual Investors Sentiment Survey. The weekly poll reveals whether individual investors are bullish, bearish, or neutral on the market for the next six months. As the'mom and pop' investors survey, it's clear that this is a'mom and pop' survey.
In the past two years, the chart below shows how many investors have identified themselves as bearish. In 2022, stocks began to fall into a bear market due to pessimism. The long-term average for AAII bearish sentiment is 31.1%. In September 2022, bearish sentiment reached 60.9, the highest level since the Great Financial Crisis. The market collapsed just a few weeks later.
The AAII Sentiment Survey can be helpful in identifying bottoms. Bearish sentiment was elevated when we hit a market bottom.
To see how the pros are feeling, we can turn to the National Association of Active Investment Managers Exposure Index. Active investment managers are being asked what percentage of their portfolios are in stocks. The answers are used to build the index. A 100-point reading would mean that you're fully invested in stocks. No one owns stocks, so zero would mean no one owns stocks. The less the index, the more bearish the pros feel about stocks. The long-term index average is 65.2.
Professionals kept equity exposure low throughout 2022, but reached their most bearish level right after the market was bottoming.
We can still observe that exposure has been well below the average at the end of the last three bear markets, the Exposure Index hasn't been around as long as the AAII's Sentiment Survey.
As easily as any other investor, the professionals seem to surrender to fear as quickly as any other investor. When investors get this fearful, it's oftentimes that they become greedy. If you're buying after most of the crappy sellers have already capitulated and stocks have fallen, you're buying right now.
The AAII bullish sentiment has averaged 42.1% so far in Q3 2023-materially higher than the long-term average of 37.5%.
The same period, the NARIM has been elevated to 75.2 compared to the long-term average of 65.2.
As a counterrian, you might be tempted to use investor optimism as a way to exit stocks-or even short the market.
Market tops don't always show a significant departure from normal sentiment. How bullish sentiment in the AAII market has been during the past five market tops of the past five years.
High bullish sentiment is not indicative of a top. When a market top forms, bullish sentiment is pretty average.
How did the Nasaim Exposure Index look at the market tops?
Two of the three bull market tops saw the pros taking on above-average exposure. The difference from the average is not nearly as great as in bear markets. As the Exposure Index has risen to 120.6 on the high side, it can go up above 100 and lower than zero. The lowest-ever recording was -3.6.
Investor sentiment can be a great indicator of bottoms, as it can be used as a counter-arbiter. CFA, Michael Joseph, CFA, is a portfolio manager and deputy chief investment officer at Stansberry Asset Management. This report should not be construed as investment advice. In any market, no investment strategy or risk management technique can guarantee returns or eliminate risk.