March 23, 2020
Austin Pickle, Investment Strategy Analyst
The Bright Side of Extreme Investor Pessimism
S&P 500 Index (top panel) versus investor sentiment (bottom panel)
The recent collapse in equity prices has investors asking, “When will this extreme stock market sell-off end?”
No investor and no trading tool can predict stock market bottoms. But there are indicators—like the one in the chart above—that can provide clues about when a bottoming process may be beginning. This chart compares a gauge of stock investor sentiment, the Ned Davis Research Crowd Sentiment Poll, against the S&P 500 Index.
What it May Mean for Investors
The current sentiment reading indicates that the stock market crowd has become excessively pessimistic. Historically, these pessimistic extremes have indicated that the pendulum has swung too far. It is too early to tell how much longer the current market sell-off may last, but in our view, the washout in sentiment is a positive development.
This chart shows perspective on a composite sentiment indicator designed to highlight short- to intermediate-term swings in investor psychology. The indicator in the lower clip of the chart is a composite reading which is based on seven different individual sentiment indicators in order to represent the psychology of a broad array of investors. The indicators used are mostly based on ratios of relative bullishness or bearishness (bullish investors as a percentage of all investors) among different categories of investors, including data from: Investors Intelligence -- surveys of stock market newsletter writers, American Association of Individual Investors -- surveys of market expectations among individual investors, CBOE Put/Call ratios -- ratio of the volume of call options to total options traded (calls plus puts) on Chicago Board Option Exchange, Rydex fund assets -- ratio of assets invested in bullish market timing Rydex funds to total assets in bullish plus bearish Rydex funds, MBH Commodity Advisors Daily Sentiment Index for the S&P 500 -- surveys of non-professional retail traders and other surveys of investors and traders. The composite sentiment reading shows what percentage of all the investors represented by the above data can be classified as bullish on the stock market at any given time.
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