American optimism reversing: time to head for the exit?

The latest US stock market sentiment statistics reveal an interesting trend.

Even though the S&P 500 is trading at record highs, US investors appear pessimistic. Normally, such unprecedented share prices could be expected to produce strong optimism, even euphoria. This is clearly not the case now!

Why are we saying this?

Graph 1 shows S&P 500 performance at the top. In the middle are the ‘drawdowns’, the corrections or bear markets, and the bottom shows how stock market pessimists or ‘bears’ are progressing. It was this trend at the bottom of Graph 1 that caught our attention.

Experience teaches us that such pessimism is generally driven by corrections or bear markets. Up until now, stock market pessimism would clearly increase whenever the S&P 500 dropped by 10%, 20% or more. Now we are still seeing an increase in pessimism, despite the fact that the S&P 500 is trading at record prices and we have not seen the stock market fall by 10% or more recently. It’s all quite strange.

Graph 1: Percentage of stock market pessimists in US

Source: All Star Charts

We do not see any obvious reasons. It is true that the ‘Magnificent Seven’ (the S&P 500’s seven top companies; Apple, Amazon, Alphabet (Google), Meta (Facebook), Microsoft, Tesla and Nvidia) have been underperforming. These shares are well represented in US equity portfolios, trackers and funds, of course. That could be a contributing factor.

What does this mean for equity investors?

Many investors rely on sentiment analysis in their investment decisions. ‘Contrary’ investors in particular may find ways to benefit from this exceptional situation.

Graph 2 illustrates how the emotional cycle works. When the vast majority of investors are optimistic, you should be building in a safety margin as an investor. Based on historical precedent, a correction or trend reversal is likely.

Alternatively, if the mood is pessimistic, it can be wise to invest, because a reversal or recovery is often close by.

In our opinion, that means vigilant contrarian investors should take this pessimism about the US market as a sign to benefit from the current ‘weak’ American exchange and build up positions.

Graph 2: Sentiment cycle

Source: Bloomberg

So, even though the US S&P 500 is trading at record prices, American investors are not demonstrating much optimism.

That is quite the contradiction. Where euphoria would normally prevail, a survey among US investors shows that the majority is pessimistic.

Are you a contrarian investor? This could be the sign you need to start building up positions in US equities.

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