Investor Sentiment on Stock Market is No Longer Wildly Bullish. We use investor sentiment as contrarians indicator on stock market direction. So, a month ago in late March the Investor Intelligence poll of more than 100 newsletter writers showed bears clearly outnumbering bulls with a negative spread of -11.6%. Negative spreads as they widen historically are strong bullish signals for the market from a contrarian viewpoint. And sure, enough the market since then moved up sharply. But with that sharp upward move, bullish sentiment has gone up while bearish sentiment has gone down. So, from that -11.6% spread a month ago, the sentiment spread during this past week increased to +12.5% (see chart below). And that means we can derive far less certainty that the market is headed for another big upward move. In fact, the higher the spread, the more it is signaling market risk, particularly at +30% and higher. In fact, spreads over +40% and higher historically signal investors should take defensive measures.
Not-too-Hot, Not-too-Cold Investor Sentiment on Stock Market Suggests Further Upside. We use investor sentiment as a contrarian indicator for where the stock market is headed. The Investors Intelligence poll of more than 100 market newsletter writers is an important contrarian indicator for the direction of the stock market. These writers tend to act like sheep with a wrong-headed herd mentality that defies reason. They are inevitably frightened and extremely bearish at market bottoms when they should be buying. Additionally, they are extremely bullish at market tops when they should be taking defensive positions. We use this to our advantage. So right now, tepidly bullish and bearish sentiment suggests the market probably will be going higher. Here’s why.
Bullish sentiment during the past week jumped to 40.9% from 33.3% last week but remained far lower than the 55% bullish level that signals defensive measures. At the same time, the market’s rebound propelled bearish sentiment lower to 32.4% from the previous 36.2%. Bearish sentiment levels below 20%, which occurred for most of 2019, usually are not attractive for buying.
Meanwhile, as the chart below illustrates the spread between bullish and bearish sentiment moved to +8.5%, ending three prior negative readings in a row when the bears outnumbered the bulls. Those negative spreads, which historically are signals to buy, once again proved to be accurate bullish indicators by signaling the latest market rally. So, what of the present +8.5% spread? That spread remains in buy territory but not as strong a buy signal as when the spreads were negative. In the opposite direction, spreads above +30% signal increasing concerns the higher they get, with defensive measures appropriate above 40%.spreads. So, what does all mean? The rapid changes in investor sentiment coinciding with the market advances and retreats suggests the markets will remain very volatile and not for action by the faint of heart until there is very clear direction.
Why Record Amount of Corporate Debt Downgrades Could Be Good News for Stock Market and Economy. The major credit agencies are notorious for waiting until the last minute when things are really bad to downgrade their ratings on issuers’ debt, particularly for larger companies like those in the S&P 500. That’s because they get their revenues from the very entities they are rating and fear the loss of future earnings if they say bad things about the companies that pay them. In other words, investors be damned! In fact, this attitude to put issuers first has proven disastrous for investors, including during the 2008 financial crisis.
So, here’s the good news. During the past month, according to Jason Goepfert at SentimenTrader, “ratings agencies have downgraded a record amount of debt on firms within the S&P 500 (see charts below)” This may be a hopeful sign, notes Goepfert. Why? Because if we judge by the past performance of the agencies, “by the time a large number of those companies have been downgraded, most of the declines have already run their course.”
Sentiment Indicators Suggesting Stock Market Bottom for Near-to-Intermediate Term. Investor sentiment indicators historically are good indicators of the direction of the stock market. So, in these times of great uncertainty it is interesting to note that important indicators from SentimenTrader are signaling a near-to-intermediate-term stock market bottom. The chart below, which is a compilation of various sentiment indicators, indicates excessive pessimism on the part of investors. That is a positive for a market bounce from a contrarian point of view because the average investor usually is wrong. Note in the chart how pessimism peaked in the past just before upward moves by the S&P 500 index (SPX).
Another widely followed SentimenTrader Indicator measures the trading patterns of so-called “dumb” and “smart money.” As the chart below shows the Smart Money/Dumb Money confidence spread remains in positive territory.
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.