As a fan of investor psychology, I find sentiment intriguing. Measuring it is a challenge. We can’t trust what people say because they become bullish after they buy and bearish after they sell, convincing themselves that past trades were the correct way to go.
Hence, we need to find more objective ways to view and measure sentiment.
That is why I find Jason Goepfert’s SentimentTrader website so intriguing. He follows an extraordinary number of indicators that track investor sentiment.
One of his recent comments has been making the rounds on social media. Paraphrased to remove the trader jargon and hyperbole, it read something like this:
The Standard & Poor’s 500 Index has traded more than half a percent above its five-day moving average for 10 consecutive trading days. In the prior 75 years, this has only happened twice – in 1982 and 2002. Each time it marked an end of a multiyear bear market. Each time it happened came after a mild, four-week drop. It’s incredibly uncommon and wholly unexpected.
The market condition that Goepfert is describing can best be called “persistently overbought.” As we have noted before, persistently overbought stock markets reflect strength and demand for equities, often in a period of deep pessimism. That’s seems like a pretty good description of current conditions.
I contacted Goepfert to see if he could provide more insight into what this unusual sentiment reading means.
On Oct. 15, SentimentTrader’s metrics reached just such an extreme. Out of 85 measures Goepfert tracks, 43 reached unusually high levels of pessimism all at once. That many metrics pinning the needle at the same time has only happened at other intermediate-term lows, according to Goepfert.
There are several other random elements at play here that could challenge the historical value of this metric. A sample set of two – 1982 and 2002 – is very small.
The second is the fact that in September stocks had recently traded at new highs, not the obvious result of “extreme pessimism.”
Then there is the issue of the Federal Reserve, including quantitative easing and short-term interest rates stuck at zero. Fed policies helped boost corporate earnings and goosed the financial markets. There is lots of skepticism that the rally is sustainable.
That sort of sentiment seems to be exactly Goepfert’s point: Historically, markets like those we’re seeing now have led to positive returns.
There has been a consistent disbelief in the validity of the market’s gains practically since the post-meltdown lows of March 2009.
Markets have rocketed higher despite, or more likely because of, this persistent disbelief.
Until that changes, the path of least resistance is upward. •
Barry Ritholtz is a Bloomberg View columnist and founder of Ritholtz Wealth Management and former CEO of FusionIQ, a quantitative research firm.
