The Plight of the Fickle Investor
People’s feelings about the stock market are disturbingly fickle, as a key investor survey demonstrated during the October downturn. Trouble is, many act on their whipsawing views and make big, avoidable mistakes.
According to the survey data of American Association of Individual Investors, Aug. 28 saw the highest number of bulls since late 2013, with 52% espousing optimism. Then came the market slide that began in mid-September and deepened into mid-October. Bullish sentiment slid to 35% in early October. But the market recovered and the AAII bullish gauge is back to greater than 50%.
Sure enough, stock buying was strong when the market and the AAII bull numbers were high. So when share prices slumped, and investor enthusiasm ebbed along with them, investors unloaded stocks. In other words, they bought high and sold low.
A large part of what moves stocks on a daily basis is human emotion. When markets move to extreme levels, smart investors often make their largest portfolio gains. Celebrated investor Warren Buffett once said, “Be fearful when others are greedy and be greedy when others are fearful.”
Managing our finances would be far easier if we could view markets like a machine void of emotion. But we are human and our powerful emotions often move markets to what some may consider extreme levels; creating opportunity for those with nerves of steel and a trusted investment plan.
Sentiment data, which is derived from surveys of individual investors, money managers or newsletter writers, can provide insight into the human emotion that drives capital markets. It’s a mistake to think the stock market is based on science.
As always, you can’t view any data set in a vacuum, and no investor should rely on a single data point. But this information helps those that are active in the market get an idea of the human emotion that has been impacted during the recent market advance.
The stock market in its simplest form is one big voting box. Each time you buy or sell a stock, bond or mutual fund, you cast a vote. Even holding cash is a reflection of market participants casting their votes.
History tells us to look at this data in a contrarian manner, taking the opposite action when sentiment swings to an extreme level. Meaning the larger the crowd that shares a single perspective, the more likely the crowd is wrong. This isn’t always the case, but if too many people are on one side of the teeter-totter, it just won’t work until the thing is rebalanced.
On March 5, 2009, the AAII survey found 70.2% of investors were bearish on the stock market, the largest amount of pessimism since 1990. Well, the Standard & Poor’s 500 bottomed soon after before rising over 60% through the rest of the year.
Markets, whether of stocks, commodities or real estate, typically overshoot their fair value level, however you chose to measure it. Investors need to look at times of panic and extreme euphoria through a clear lens.
Having a defined investment plan is vital to navigate the choppy waters of the capital markets. The investment world is more of an art form once you strip away the complexity, and when viewed in the right light it can be a beautiful thing.
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Written by Joseph “Big Joe” Clark, CFP, is the managing partner of the Financial Enhancement Group LLC, an SEC Registered Investment Advisory firm in Indiana. He teaches financial planning at Purdue University and is the host of Consider This with Big Joe Clark, found on WQME and iTunes. He is a Registered Principal offering Securities and Registered Investment Advisory Services through World Equity Group, Inc, member FINRA/SIPC. Big Joe can be reached at email@example.com, or (765) 640-1524. Follow him on Twitter at @Big Joe Clark and on Facebook at http://www.facebook.com/FinancialEnhancementGroup.
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