BEFORE a market sell-off can reverse course, investor sentiment must plummet — not soar. That may sound counterintuitive, but the accepted wisdom on Wall Street is that it’s only after investors give up on stocks that prices can start to climb again.
The question is, have investors reached that point?
After a market peak on April 23, the Standard & Poor’s 500-stock index slumped as much as 16 percent, a slide classified as a correction but not a bear market, which is typically defined as a decline of 20 percent or more. After last week’s gains, the index was 9 percent below its April peak.
Yet market strategists note that recent surveys of investor sentiment point to an unusually swift eruption of bearishness ever since fears of another economic downturn started pressuring stock prices in late April. On July 14, the Investors Intelligence adviser sentiment survey — a widely followed gauge of the opinions of more than 100 independent investment newsletters — found that for the first time since April 2009, there were more bears than bulls among newsletter advisers. The July 21 survey showed equal numbers of bears and bulls.
A similar study, released on July 8 by the American Association of Individual Investors, found that the percentage of individuals who classified themselves as bearish had jumped to more than 57 percent, up from 42 percent in the previous week.
Though this figure sank back to 45 percent last week, the July 8 reading represented the highest degrees of pessimism among investors since March 2009.
“Given how awful the situation actually was early last year, it is amazing that sentiment is as negative now as it was back then,” said Edward Yardeni, president of Yardeni Research.
But is bearishness such a bad thing? Actually, no.
James B. Stack, editor of the InvesTech Market Analyst newsletter, based in Whitefish, Mont., pointed out that the July 8 study showed that the ratio of bears to bulls was greater than 2.7 to 1.
Historically, when the bear-to-bull ratio has risen above this level, the Dow Jones industrial average has posted gains of 5.4 percent and 11.4 percent, respectively, after three and six months, he noted in a recent report. To be sure, not all sentiment gauges are signaling that investors are throwing in the towel on stocks.
For example, in late 2008, at the height of the financial panic, the Chicago Board Options Exchange Volatility Index, or VIX — which measures investor expectations for market volatility — rose to a record level of more than 80. But it is far from such heights today. In fact, it is now at 23, after a climb to 45 in late May.
And while investors in 401(k) retirement plans have signaled skittishness by reducing their equity allocations, their risk aversion isn’t close to where it was when the market bottomed in March 2009. Still, many market strategists regard the market mood as being at extreme lows.
Perhaps what’s most surprising isn’t that stocks have climbed in periods of pessimism. Rather, it’s worth noting the types of stocks that have thrived.
BRIAN G. BELSKI, chief investment strategist at Oppenheimer, studied how various sectors of the market have performed in glum times over the past 20 years. Looking at the investor association’s survey and using a different ratio — that of bulls to bears — he found that 12 months after that ratio declines a certain point below the historical average, the markets tend to take on a split personality.
On the one hand, a couple of traditionally defensive areas of the market — health care and consumer staples companies, which aren’t terribly dependent on a strong economy — have traditionally done well 12 months after extreme pessimism sets in.
But two economically cyclical sectors of the market — specifically, technology, and consumer discretionary l stocks — have actually done better. Tech stocks in the S.& P. 500, for instance, have historically been up more than 14 percent one year after market pessimism has sunk to extreme lows.
Since market volatility began to soar in late April, the defensive areas of the market have lost the least. But if history is a guide, market bearishness may be telling investors not to just bet on stocks, but to broaden their strategy by investing in economically sensitive shares as well.
Paul J. Lim is a senior editor at Money magazine. E-mail: fund@nytimes.com.
Read Full Article »