How do you measure investor sentiment? With the volatility index? By counting the number of Wall Street analysts crying in bathroom stalls on any given day?
Last Friday, we wrote that sentiment stinks because…well, it does. The University of Michigan’s consumer sentiment survey sank to 57.9, its lowest reading since November 2022, while the latest AAII Investor Sentiment Survey showed that 59.2% of individual investors feel bearish about markets over the next 6 months.
But it turns out that could be a good thing for the stock market. You see, when investors get too optimistic, it’s actually a strong contrarian signal that the market has overextended itself and is due for a pullback—and when sentiment gets too low, it might be a buying opportunity.
Sagging sentiment
Goldman Sachs tracks investor sentiment using a complex system of proprietary indicators, such as hedge fund net exposure, foreign investor demand for US stocks, investor inflows and outflows, and more. The eggheads on Wall Street throw these signals into a pot, let it simmer on medium heat, and pop out a handy chart like this one that indicates how the market is feeling at any given moment.
Goldman Sachs
When sentiment is over 1, it means investors are too optimistic, and a pullback may be on the horizon. The highest reading of the last 12 months was on November 29, 2024, when sentiment hit a whopping 2.78. That was the heyday of the post-election boom, when markets were sure that a second Trump administration would usher in a business-friendly era of low taxes and high growth.
Instead, tariff uncertainty threw investors for a loop, upsetting any hopes of easy wins powered by President Trump, and the S&P 500 has tumbled tk% since 11/29/2024.
An overdone selloff
But fear not (actually, fear more—since that means the market may be due for a recovery): When sentiment falls below -1, investors are too pessimistic, and stocks could be gathering strength for a comeback.
Making sense of market moves
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According to Goldman Sachs’ latest reading on March 14, sentiment has fallen to -0.58, its lowest reading since May 18, 2023. Back then, sentiment was still recovering from a bear market that had gripped stocks throughout 2022—but since that day, the S&P 500 has risen tk%.
Not too shabby for a bunch of downbeat investors.
Time to buy?
If you’d prefer alternative measures of pessimism, the VIX, or volatility index, is the most commonly used barometer. As the analysts at DataTrek noted the other day, “A VIX close of 19.5 (long run average) tends to signal a floor for stock prices during bull markets but a ceiling in bear markets. Such was the case in 2022, for example, when the VIX hit that level 3 times and the S&P was down over the next month on every occasion.” The VIX currently sits at tk.
Keep in mind…this is not a perfect system. Sentiment could stink for good reason, and continue to fall from here, and drag the market down with it. But nobody ever said being greedy when others are fearful was going to be easy—and ultimately, being a contrarian might turn out to be the best way to invest right now.—MR
