Market Sentiment Is Down. Is It Time To Buy Stocks?

Forbes

01-05-2025

NEW YORK - JULY 16: A trader rubs his eyes outside the New York Stock Exchange July 16, 2002 in ... More New York City. The Dow closed down in seven straight losing sessions, falling more than 900 points, despite some soothing words from Federal Reserve Chairman Alan Greenspan about the economy. Investor concerns over earnings and recent corporate accounting scandals contributed to eight weeks of loss. (Photo by)
Investors have endured notable pain this year, with the S&P 500 suffering one of its fastest 10% corrections over the last 50 years, then nearly tipping into a bear market. This has thrust sentiment to a lowly place — one typically reserved for the depths of a bear market or a financial crisis.
Interestingly though, sentiment hits these troughs when the S&P 500 was only down about 3% from its record highs.
If we look at the AAII survey, the number of bullish respondents plunged below 20% on February 26th, while bearish responses rocketed above 60%. Not only were these readings considered to be in extreme territory, but going back to 2000, breaches of these levels have typically correlated with a notable low in stocks.
Extreme sentiment readings have often been a contrarian indicator. Meaning extremely bullish readings have historically been associated with a short-term top in stocks, while extremely bearish readings have typically come into play near the lows of a selloff.
In other words, late-February's sentiment readings may have seemed like a great time to buy, and historically, that's been true. This time though? Not so much. At its low in April, the S&P 500 was down almost 20% from when those sentiment readings first dipped into extreme territory.
So that begs the question: Is sentiment still a contrarian indicator or is it becoming a leading indicator and preceding larger moves in the market?
25-year chart of AAII bullish sentiment readings.
Today's investors aren't waiting to read the newspaper to find out what's happening in markets. Real-time alerts and social media have created a world where information moves at a blazing pace, and in an era where investors can get in and out of positions with a few swipes on their phone, it appears that their attitude towards stocks can change just as quickly, too.
Whether this ends up hurting or helping investors will vary. However, it's hard to view today's investment landscape without noticing that sentiment moves nearly as fast as the markets do, while the change in stock prices can drive a bulk of these sentiment shifts.
Even when sentiment does sour though, retail investors are often trying to find the positives. That's as they tend to view pullbacks opportunistically, stepping in to buy during market corrections. It helps that many are becoming privy to the idea that pullbacks tend to be good opportunities for long-term investors.
That buy-the-dip mentality is true during minor corrections and it's true during steeper downturns as well. We know that from recent survey work, as well as interacting with clients.
A lot has changed in the markets over the years. For instance, the introduction of electronic trading, the steady flow of 401K funds, and evolving leadership groups driving stocks to new record highs.
One thing that hasn't changed much over the course of history? Human emotion.
While artificial intelligence, algorithmic trading and other automation tools may help stifle some of the emotional influence in markets at times — and stoke the flames at others — new highs and breathtaking declines still get a rise out of investors' emotions.
Those animal spirits — like fear and greed — are as prevalent now as they were 100 years ago.
In the current environment though, we're not seeing sentiment act as a contrarian indicator, it's been a leading indicator. Extreme bearish readings came into play before markets took a significant turn for the worse, and through April, they have only improved modestly. In 2022, we saw some early signs of extreme bearish sentiment before stocks ultimately bottomed later in the year, too.
This plays on the idea that investors are reacting more quickly to changing dynamics in the markets. However, consider that two things can be true at once, where sentiment becomes overly bearish early in the decline before markets eventually bottom on bearish sentiment. Regardless of whether sentiment becomes a leading indicator, one thing is unlikely to ever change: Markets won't bottom on bullish sentiment.