Investor Pessimism a Good Thing

Courtesy of Sandra Boyd, Posted 22 Sep 2015

Investor pessimism has risen to levels not seen since Federal Reserve Chairman Paul Volcker began raising rates in the 1980s.  Despite the long list of bearish headlines that has led to this deterioration in sentiment, there are several reasons why a negative investor outlook is actually a good thing for markets. A Bloomberg News article featured in the Financial Post tells us why:

  1. Earlier this month, the bull-to-bear ratio in Investors Intelligence’s survey of newsletter writers fell to a four-year low of 0.9. In April, when bulls prevailed, the ratio reached 4.1
  2. The cost of puts protecting against a 10 percent drop in the S&P 500 rose to a record on August 24 relative to calls betting on a 10 per cent rise.  Meanwhile, speculators increased short positions on stocks to the highest level since March 2009
  3. Investors have been ultra-sensitive to the slightest hint of trouble.  This distrust has a been a barrier to euphoria, a quality that has historically been the bigger threat to bull markets
Biggest Rallies
  1. Bearish sentiment has dominated in three other periods in the last 6 ½ years: April 2009, August 2010 and October 2011.  In all cases, the S&P 500 rallied for two straight quarters with gains exceeding 20 per cent
  2. The last time sentiment fell as quickly as it has recently was June 1984, when the S&P 500 was close to completing a nine-month decline and Volcker had implemented another round of rate hikes.  As the Fed began easing, stocks advanced in the next five years
  3. ‘The nervousness means people have stepped to the sidelines.  The question is, who is left to sell?  Everybody who has cash is a potential buyer’ says Bob Doll, chief equity strategist at Chicago-based Nuveen Asset Management which oversees US $130B and bought stocks during the August selloff
US Strength
  1. US unemployment has fallen to the lowest level in seven years, housing and auto sales are booming and rising retail sales cannot be ignored.  Yet bears who focus on China and oil are doing just that
  2. While falling oil and a rising US dollar are forecast to weigh on 2015 earnings, analysts predict profit will rebound in the next two years
  3. Concerns over China and emerging markets ‘are likely to be proven misplaced over the next six to 12 months because the underlying picture isn’t as dire as people are worried about today’ said Jason Pride, director of investment strategy at Glenmede which oversees US$30 billion


A look back at major market meltdowns reminds us that they are almost always preceded by a period of unbridled optimism. Blind faith leads to unrealistic valuations and the mechanism feeds on itself until the system collapses.  Clearly, euphoria is currently a long way off and while that does not mean that markets are impervious to continued volatility, is does mean that current valuations paint a clearer picture for the portfolio managers we hire to manage our money.