The Wisdom of Crowds

Do you ever scratch your head and wonder at how the stock market can continue to go up while many around you seem so pessimistic about investing? I've previously written about how individual investor sentiment has lagged that of institutional investors, even as the economy grows and the bull market continues. But this phenomenon has been playing out for awhile and there are many reasons why. 

Along these lines, check out an excellent piece on the subject from one of my research partners, Bespoke Investment Group:

Two of the most widely followed stock market sentiment indicators come from Investors Intelligence and the American Association of Individual Investors. The Yale "Stock Market Confidence" indices are much lesser known, but they provide key insights into investor sentiment trends nonetheless.

The Yale School of Management has been surveying both individual and institutional investors for nearly two decades now, and below we provide historical charts that track the four survey questions they ask investors each month.

The first survey highlighted below is Yale's "one-year confidence" reading which asks investors if they think the stock market will be up one year from now. As shown, this reading has been trending lower for years now, but we've seen a massive spike in expectations from institutional investors and only a minor pick-up from individual investors. In this regard, it appears that institutional investors have turned significantly more bullish since the election, while individual investors simply aren't sold.

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The second survey question asks investors how confident they are that the market will rise the day after a sharp fall. Yale calls it the "Buy on Dips" measure. Similar to the "One-Year Confidence" reading, we've seen a big divergence between institutional and individual investors for the "Buy on Dips" measure. Institutional investors have gotten very confident to buy on dips, while the reading for individual investors just recently hit new lows.

The third survey question asks investors how confident they are that there will not be a stock market crash in the next six months. For this reading, the lower the number, the more concerned investors are about a crash, and vice versa. Interestingly, both individual and institutional investors have become less confident that there won't be a stock market crash in the coming months. It's not surprising to see the reading where it is for individual investors, but it is surprising to see that institutional investors are just as concerned about a stock market crash even though they're much more bullish on the stock market based on the readings above.

The final question asks investors how confident they are in the valuation of the market. Here, low readings mean investors don't think the market is attractively valued, and vice versa for high readings.

As shown below, both individual and institutional investors have become less and less confident in the valuation of the market over the years, and the reading keeps hitting new lows for individual investors. The reading for institutional investors is extremely low as well.

Based on all four readings, individual investors seem less than enthusiastic about stocks, even after the election. For institutional investors, they're bullish on the market, but at the same time, they don't think it's attractively valued and they're concerned about a crash. To us it seems like institutional investors are basing their bullishness on hope.

As highlighted above, institutional investors are much more optimistic about the stock market than individual investors. Remarkably, this is a trend that has been in place for more than ten years now!

In the chart below, we show the spread between the average institutional investor reading (based on all four of Yale's survey questions) and the average individual investor reading. When the spread (blue line) is in positive territory, it means institutional investors are more bullish than individual investors. As you can see, the spread has essentially been in positive territory since 2005, and it just recently hit an all-time high. Over the years we've written a lot about the plight of the individual investor and the impact that two 50%+ drawdowns for the S&P 500 over the last 20 years have had on individual investor sentiment. It's the old "fool me once, shame on you... fool me twice, shame on me" saying, and they don't want to be burned again.

The current bull market is about to enter its 8th year, and we still haven't seen individuals turn bullish on stocks. If a 200% rally over 8 years isn't enough to draw them back in, we don't know what will. At this point it looks as if the only remedy is going to be time — and it's not going to be months or years, but maybe decades.

If you're interested in more from Bespoke, here's a link to follow. This is a subscription service but they do publish a blog that is accessible for free. 

https://www.bespokepremium.com/

Have questions? Ask me. I can help.