Newsletters Give Up. There are a few go-to indicators that casual observers tend to gravitate to when discussing “sentiment.” One of those is the survey of newsletter writers by Investor’s Intelligence.
Despite the tumult in markets in recent weeks, the survey hadn’t shown much give-up, which changed this past week. For the first time in well over a year, the Bull Ratio (Bulls / (Bulls + Bears)) dropped below 50%. This means that more of them expect stocks to decline than rally in the months ahead.
This ends one of the longer streaks of bullishness in the survey’s history.
Sentiment Indicator Showing Widening Divergence On Outlook for Stock Market Between “Smart” and “Dumb” Investors. SentimenTrader’s Smart Money/Dumb Money Confidence Spread shows that the recent huge stock market declines are triggering outright panic and increasing pessimism among so-called “dumb money” investors. Meanwhile, the huge declines are making the “smart money” increasingly optimistic about a bottom. The chart below shows the widening spread between the two groups. This is an indicator that we will continue to watch closely.
Investor Sentiment is Extremely Fearful, Indicating Stock Market is Oversold: But Be Careful! We use investor sentiment as contrarian indicators of where the stock market is headed because investors historically are wrong. The recent huge market drops have driven investor sentiment to levels of extreme fear, indicating the stock market has become oversold. That spells buying opportunities based on the historically accurate sentiment indicators we follow. However, we also caution our readers to be very careful. That’s because the great amount of economic and political uncertainty out there could trigger further market drops following upward moves that could drive the market to overbought levels and sentiment from fear to greed.
For instance, the investor CNN Fear/Greed short-term stock market indicator at a level of 3 is showing extreme fear in contrast to greed a month ago well before the big market drop (see chart above). Meanwhile, SentimenTrader’s Smart/Money Dumb Money Confidence Spread is showing growing optimism among smart investors while fear pervades the so-called dumb investors (see chart below).
Why Increasing Investor Stock Market Pessimism Doesn’t Mean It is Time to Buy. We use investor sentiment as contrarian indicators about the direction of the stock market because historically investors are wrong. Although sentiment indicators are showing growing investor pessimism about stocks as an investment, they have not reached historical fear levels that we believe usually indicate the market is oversold and that we’ve hit a firm bottom. In other words, the sentiment indicators are not yet flashing strong buy signals for major buying opportunities.
For instance, the Investor Intelligence poll of more than 100 stock market newsletter writers and editors shows bullish sentiment for the intermediate term decreased sharply to 41.7%, from 49.1% and 54.7% the prior two weeks. That’s the lowest level since January, but in our opinion still indicates caution from a contrarian viewpoint. Meanwhile, bearish sentiment among these so-called market prognosticators increased slightly to 20.4% from 19.2% the previous week but hasn’t hit higher levels suggesting major buying opportunities. The spread between bullish and bearish sentiment narrowed to +21.3%, from +29.9 and 35.8% for the previous two weeks (see chart). The lower the spreads go the lower the risk, but the spread at this level we believe still is signaling caution. Negative spreads when there are more bears than bulls, historically point to strong buying opportunities and low risk for longs.
Another important sign of growing pessimism comes from the SentimenTrader Smart Money/Dumb Money Confidence Spread (see chart), which is moving in the right direction. But all in all, the sentiment indicators at these levels, we believe, still call for caution.
Investor Sentiment Indicates Stock Market Remains Precarious. We use investor sentiment as a contrarian indicator of market direction because the average investor historically is usually wrong.. Although the short-term CNN Fear/Greed index is now registering extreme fear on the part of investors, we believe that as a contrarian indicator that this is not yet a signal that it is time to buy. History tells us the market for the short-term and intermediate-term despite the major drops has not reached an oversold level. So be careful.