Author: David I. Templeton, CFA, Principal and Portfolio Manager
This week's American Association of Individual Investors' Sentiment Survey showed a significant decline in bullish sentiment and a commensurate increase in bearish sentiment. Individual investors are expressing cautiousness about equity returns over the next six months. One aspect associated with sentiment measures is they tend to be contrarian measures at their extremes though. In other words when individuals are the most bearish, the equity market tends to be at or near a low point.
As the below chart shows, the bull/bear spread is a large negative -41.23%, i.e., bearish sentiment exceeds bullish sentiment by 41 percentage points. As the chart shows, this is one of the widest spreads going back 20 years. The red notations on the chart signify low equity market points: the financial crisis low in March 2009, the COVID low in March 2020 and the equity market low in September 2023, just to name a few.
The next chart shows the 1-year S&P 500 Index return leading by one year. For example, at the March 2009 financial crisis low, the subsequent 12-month return for the S&P 500 Index was just under 70%. Similar strong returns occurred after the COVID low and the September 2023 low.
The below table details the subsequent 12-month return for the S&P 500 Index in the prior ten times the AAII bull/bear spread fell below -40%.
Lastly, there are no certainties with any one market measure. The next chart shows the weekly bullish sentiment reading along with its 8-week moving average. The moving average smooths the potentially more volatile weekly readings. Notable with the 8-week measure though is the fact it can decline to a much lower reading than its current 31.85%; thus, it may take a few weeks for the market to put in a bottom.
As noted at the beginning of the post, sentiment measures are contrarian ones. Certainly, the individual investor is expressing a weak view of equity market returns over the near term or next six months. Whether this is justified, one will know in hindsight, yet fourth quarter corporate earnings reports are coming in strong. Through February 21, Q4 2025 year over year earnings growth for S&P 500 companies is expected to be up 15.7%. This double-digit growth rate is expected to carry into the four quarters of 2025. If there is truth to the fact stock prices tend to follow earnings, maybe the individual investor is being too pessimistic.
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