Does Investor Sentiment Predict Performance?

Does Investor Sentiment Predict Performance?

Warren Buffett of Berkshire Hathaway fame tells us to be fearful when others are greedy and greedy when others are fearful. If that’s the case, it’s time to be greedy!

Each week for the last 35 years or so, the American Association of Individual Investors (AAII) has been asking its members whether they are bullish, neutral or bearish on the stock market over the next six months. Last week, fewer than 16% of respondents were bullish. That’s the lowest read since 1992! (This week, the bullish camp swelled a smidge, to 19%, which is still historically very low.) Fewer investors are bullish today than during the COVID-19 lockdowns, the global financial crisis or the bursting of the tech bubble.

In an effort to reduce the hyperbole—and to take some of the noise out of this survey—I like to look at the broader trend rather than week-to-week gyrations. Over the past two months, using an eight-week average of the percentage of bullish respondents, one-quarter of respondents expressed bullishness. This isn’t as extreme as the recent weekly figures, but it still reflects an unusually low level of bullish responses. (For you statisticians, the percent of bullish responses is more than one standard deviation below normal.) This tells me that investors are fearful.

In the past, when bulls have been this rare, stocks have gone on to deliver better-than-average returns. Since AAII began surveying its members, the S&P 500 (price only) has gained an average of 9.9% in all 12-month periods. However, if you look at the 12 months after bullish responses dried up (defined as the eight-week average falling one standard deviation or more below normal), the S&P gained 16.9% on average. And if you look at the opposite scenario, when a large number of respondents were bullish, the S&P went on to gain just 2.6% on average over the next 12 months.

Maybe Uncle Warren is on to something.

One final stat, going back to that weekly survey with just 16% bullish respondents: Until now, there have only been 33 weeks in AAII history (which covers more than 1,800 weeks) when fewer than 20% of the respondents were bullish. On those 33 occasions, stocks went on to gain 19.5% (on average) over the following year. While it might be uncomfortable to hold your stocks today, history tells us that a little short-term discomfort can be rewarding.


Note: Chart shows average performance for the S&P 500 index (excluding reinvested dividends) over the periods and conditions indicated in the chart based on eight-week average AAII sentiment survey responses. Sources: American Association of Individual Investors, Adviser Investments.

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