In mid-December, we wrote a quick note highlighting an overly pessimistic signal coming from the weekly survey of investor sentiment published by the American Association of Individual Investors (AAII). As we noted then, an abnormally low number of investors in this survey were expecting stocks to head higher over the next six months, and this was a good sign for stock markets because excessive pessimism can often provide a springboard for markets to go higher (and a margin of safety reducing the scope for losses).
True to form, stocks have rallied significantly in the nearly six months since then, and now sit about 6% higher than when the mid-December survey was taken. Despite this rally, there is a renewed lack of optimism in the AAII survey. At 24.7%, the number of bullish responses has once again dropped, and now sits at a level of pessimism that's deeper than about 92% of all prior readings. As noted in the table below, stock markets tend to perform very well when optimism falls this far.
Pessimism tends to support stocks as their worries fade
Forward-looking 6- and 12-month S&P 500 returns, and frequency of losses, based on the % of bullish responses in the AAII survey
Buying the S&P 500 at this level of pessimism has historically resulted in an average return of 10.6% over the next six months and 18.5% over the next 12 months. This is partially due to a much lower-than-usual likelihood of losses over both time-frames, and partially due to greater upside as markets have historically climbed this "wall of worry."
With pessimists, you know where they stand...but with neutrals, who knows?
Perhaps the most surprising feature of this bout of pessimism is that it has come in spite of an environment that's been positive for investors. When this latest AAII survey was taken—in the week ending 22 May—the S&P 500 was within 3% of its last all-time high, set just a few weeks prior; by contrast, stocks had fallen about 11% below their all-time high by the time we saw this level of pessimism in the fourth quarter.
This is perhaps why the December survey had a much lower share of neutral readings and a much sharper uptick in outright bearish responses: today, 39% of the survey replies were neutral and 36% were bearish; in mid-December, only 30% were neutral and 49% were bearish. Historically, a high level of neutral readings has also been a positive sign for stocks; when neutral readings have been this high or higher, 12-month S&P 500 returns have been about 15.5% on average, with only 10% of these periods seeing a loss.
Investor sentiment wouldn't be enough on its own for us to recommend a risk-on stance, but for investors that have found themselves sitting on the sidelines it is yet another good reason to put excess cash to work today, rather than waiting for a deeper dip.
Author:
Jeremy Zirin, CFA, Head of Equities Americas, UBS Financial Services Inc. (UBS FS) David Lefkowitz, CFA, Sr. Equity Strategist Americas, UBS Financial Services Inc. (UBS FS) Edmund Tran, CFA, Equity Strategist Americas, UBS Financial Services Inc. (UBS FS)
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