For years, market strategists have tried to explain that
investor bullishness is bad for future stock returns, and when
investors are very bearish, it's a great time to buy. They're
right. I've gone over 25 years of data compiled by the American
Association of Individual Investors (
), and found this investing maxim to be remarkably accurate. And
guess what? The AAII's weekly survey has just revealed another low
in investor sentiment.
First, let's take a look at what happened in the late 1980s when
investors had just come out of a sharp market crash (the infamous
of October, 1987) and sentiment was fairly bearish. This table
shows the annual low point for investor sentiment from 1987 through
1993 and how the market subsequently fared. Throughout this period,
investors were very bearish, and less than one in five investors
considered themselves to be bullish. Those lonely bulls sure made
some money, though.
If you bought stocks at the annual low point in terms of investor
sentiment, your three-year return would have been at least +37% in
every one of those years, or roughly +11% on an annualized basis.
In some of those periods, annualized returns approached +15%.
In the ensuing years, investor sentiment was never again so bearish
(expect for a quick dip in 2003 and 2005). But by 2008, the AAII
survey was once again showing bulls to be a lonely group. Investors
that chose to wade in while sentiment was very bearish in 2008
surely got burned, as the markets absolutely cratered in subsequent
months. So this approach is not foolproof.
But more recently, the strategy has once again been paying off.
Fully 70% of investors were bearish at the beginning of March,
2009. Yet, one year later, the S&P 500 was more than +60%
higher. Last November, when the bears were once again on the prowl,
gutsy investors would have made a decent +6% gain in the next six
This brings us to the latest AAII reading, which shows that bulls
are again becoming a lonely crowd, with only one in five investors
citing optimism. That's partially due to a series of weak recent
economic reports, but it's also due to the fact that the S&P
500 is on track for its third straight losing week and has fallen
-14% since early May. That's the main takeaway of this analysis.
Investors tend to turn bearish after the market has posted weak
Action to Take -->
In times of heightened bearishness, it's important to separate
companies that are truly heading into tough times from companies
that are operating at a steady pace but are simply unloved because
investors are selling stocks. The latter group is what you want to
focus on when making a watch list of stocks to buy.
As a short list of companies that I believe will continue to post
decent results, yet are now well off of their highs, you can take a
Best Buy (
Charles Schwab (Nasdaq: SCHW)
American Superconductor (Nasdaq: AMSC)
The New York Times Co. (
Ford Motor (
If the market begins to strengthen, these names will likely see
fresh buying interest.
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.