Investor Sentiment Signaling Bad News for Equities?

When I first got in the business I remember an older financial advisor saying to always remember the individual investor does the wrong thing at the wrong time. I don't necessarily follow contrary investing, but this statement has always been in the back of my mind.

In my opinion, the investor sentiment index is one of the most useful pieces of information in the marketplace. Not to be confused with consumer confidence, which I tend to find useless, investor sentiment really has been supported with data for 40 years.

To simply put it, when investors feel good about the market and aren’t afraid of adding money to their portfolios, they are usually met with disappointing returns over the following 12 months. Measuring investor sentiment since 1970, the Bull and Bear report shows that when sentiment is between 80% to 95%, the returns on the stock market 12 months later are negative. In fact, when investor sentiment has been measured above 90%, the stock market returns on average were down 10% 12 months later.

Conversely, when individual investor sentiment is very low, times when as we say in the business, you can give stocks away, is usually the time you want to invest. The data show that when investor sentiment is low, 20% up to 50%, returns on the stock market 12 months later has averaged about 15%.

All of this supports what my friend advised me many years ago about the individual investor truly being a novice.

Over the last few months, investor sentiment has been very high, hanging around the 80% confident level. When you combine this statistic with lower earnings forecasts and a slow world economy, it’s a time to consider reducing your equity exposure. As I see it, there are many reasons for stocks to go lower from here, and very few reasons for stocks to go a lot higher.