Is Investor Bearishness Overstated? Or Overrated?

Investors and economists vary on how much credence they are willing to give to any single survey.   The excessive bearishness of last week’s AAII survey  came  as  the Dow Jones Industrial Average was challenging 12,000.  We could not help but wonder if the absolutes of bullish, bearish, or neutral sentiments were part of the problem because many investors are not really trained to think that way.

The AAII survey from last week noted the following:

• Bullish sentiment was down 5.8 points to 24.4%, the lowest since last August.
• Bearish sentiment was up 14.4 points to 47.7%, the highest since last August.
• Neutral sentiment fell by 8.5 points to 27.9%.

As of about 2 PM Eastern Time today, our poll from late Friday which was sent to our open newsletter readers over the weekend had 889 responses.  We admit that generally we would prefer for a poll to have more than 1,000 responses for a much more certain outcome.  Our take  is that investors either want to look for bargains, or that they think stocks will continue to slide, or that they indecisive and have decided to move more into cash to hide out during uncertainty.  This makes our outcome far different from the AAII survey and we cannot help but wonder if the investor community is getting overly bogged down by the economic numbers being reported today and by absolutes of all the world’s woes.

The “caution” cannot be avoided in either study, but the AAII survey would lead you to believe that far more market participants are out of the market for months.  Our poll that chased the AAII survey shows that there may be close to an equal number of investors who are starting to look for bargains now that stocks are so far off.

We ALWAYS have at least some doubt about  polling results.  This is true whether it is our own survey or whether it is someone else conducting a survey.  Behavior is often modified in studies, and there is an old saying that lab rats behave differently once they realize they are lab rats.

Regardless of how the results can be compared, or shown to be in fault, it seems fair to say that you can  argue that we are on the front-side of the next recession or that perhaps the caution and weak data is just transitory.  If you look at the chart below from StockCharts.com comparing the May and June performance of 2011 to 2010, it is hard to ignore at least some of the similarities. Maybe this time really is different.  You can always find someone who will say “This time is different.”

As a reminder, extreme survey readings are generally reverse indicators.  The big bounces come when investor sentiment is at its worst.  The biggest sell-offs occur when the bulk of investors are at the most bullish levels.  The trick is knowing when the inflection actually is.  Markets can remain irrational longer than most can remain solvent.

Another great market slogan came from George Soros where he noted, “Contrary to the tenets of market fundamentalism, financial markets do not tend toward equilibrium; they are crisis prone.”

JON C. OGG