A recent article in the Wall Street Journal called this “The Most Pessimistic Bull Market in History.” It’s difficult to argue against such a claim. Since 2009, the coverage of this bull market and economic expansion has focused on ‘below average’ GDP growth, little-to-no wage growth and an economy that’s seemingly treading water seven years after the financial crisis.
Indeed, according to a survey by the American Association of Individual Investors (AAII), only 27% of investors are bullish about the direction of the market over the next six months. That’s well below the historical average of 38.5% being bullish and it’s near the sentiment lows that characterized the market during its low point in March 2009.
Recent investor preferences seem to reflect this dour view. I wrote in my previous column about defensive sectors, and how they have a tendency to outperform during more difficult periods in the market. They also tend to fall into favor when investors get skittish, and we’re seeing that now—of the 10 S&P 500 sectors, two have reached new highs as I write this column: utilities and consumer staples. As the Wall Street Journal article humorously put it, those two sectors are the “antithesis of exuberance.”
What to do about Pessimism and Negative Sentiment
At any given point in time in the short term, the market is moved by any number of factors, data and the culmination of billions upon billions of investor decisions. Over time, however, there are really three key types of influences on market trends: economic, policy and sentiment.
Economic—The economics are fairly straightforward. To get an economic overview, ask yourself several questions about the global economy and/or the developed economy you’re investing in (i.e., the U.S.) such as:
Policy—Policy has to do with how capital is being regulated. One is wise to review the specific nature of the policy and the direction it’s going:
Sentiment—Then there’s sentiment. Its role on influencing the markets has been made famous by some of the most legendary investors in history. John Templeton: “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” Warren Buffet: “Be fearful when others are greedy and greedy when others are fearful.”
The point here is that, at extreme levels, sentiment is actually a contrarian indicator. When investors are blind to risk because they’re too euphoric (think tech bubble 2000 or mortgage frenzy 2005-2007), the prices of risk assets rise beyond sustainable levels. The opposite can also be true—when investors essentially ‘give up’ and capitulate in the depths of corrections or bear markets. This is possibly the most opportune time to buy. In my view, it’s hardly a coincidence that investor sentiment, as measured by the AAII surveys, hit its low in March 2009—that’s when the bear market bottomed out and the bull market began!
Bottom Line for Investors
Thinking back to Templeton’s quote, I’m not convinced this market is headed for euphoria; growth is too slow and it’s too late in the cycle for this to be likely. What I do think could kill this bull market, however, is complacency. If corporate earnings recover and China and Europe post better than expected returns this year, you might see investors give-up on being pessimistic and pour into equities as they don’t want to miss any further upside. To me, doing so characterizes euphoria-like behavior: buying stocks without regard to valuation or risk. Furthermore, too many investors willing to overpay for equities could also mean wildly overvaluing them.
Disclosure