(Bloomberg Opinion) -- By some measures, US stock market sentiment is just about as negative as it was in March 2009, right before the S&P 500 Index began its 10-year bull market that helped investors quintuple their money. As tempting as it is to take the other side of that doom-and-gloom trade, investors should consider fighting their contrarian instincts. This is a much different market, and the negative sentiment may well be justified this time.
The American Association of Individual Investors’ weekly survey shows that bearish views on the market trajectory for the next six months far outnumber the bullish ones, with the ratio now at about 3.4-to-1, a level of pessimism more or less unparalleled since the wake of the financial crisis. That’s been the case more or less since April, with a few temporary mood swings for the better along the way.
Traditionally, these levels of negativity have been fantastic times to invest: The S&P 500 rallied almost 38% in the three months after sentiment soured in March 2009 and about 67% during the next year. In fact, investing during such sentiment extremes has essentially never been a losing proposition in the post-crisis era. Still, there’s a strong argument to be made that things are changing.
First, observe that the pattern has already been broken. Sentiment as measured by the AAII survey has been extremely bearish since late April, and anyone following a strict contrarian strategy would have gone all in when sentiment dropped that month. But the market is down about 10.6% in the period, albeit with a couple tradeable bear-market rallies in the middle. Three years from now, will this go down as a decent time to have bought stocks for the long run? Possibly. But it’s hard to bet that the market bottom has been reached.
Next, there’s the interest-rate environment to consider. The biggest contrarian buying opportunities in the table above — namely, March 2009 and July 2020 — both have in common that the Federal Reserve had just finished slashing interest rates to nearly zero. Investors are now contending with the opposite rate outlook. As Fed Chair Jerome Powell underscored in his press conference last Wednesday, the US central bank is set on pushing interest rates significantly higher and keeping them there until it has clear and convincing evidence that the worst inflation in four decades is coming under control.
Finally, there are valuations, which typically sink in the event of a bona fide sentiment wipeout. During the financial crisis, forward earnings multiples bottomed below 10; and in March 2020 they reached 14. At around 16 times forward earnings now, most of the S&P 500’s multiple contraction reflects high risk-free rates but little of the additional risk premium that investors typically demand for equities in a recession.
Investors may say that they’re bearish in surveys, but the multiples they’re using to value equities imply they don’t entirely mean what they say, even after last week’s declines. Until that negativity is fully reflected in asset prices, longer-term investors won’t find a lot of utility in trying to read the market’s mood. We’re living in a new market paradigm, and investors’ playbooks will just have to adapt.
More From Bloomberg Opinion:
- Get Ready for the Great British Fire Sale: Chris Hughes
- What Comes After a Week That Shook the World: John Authers
- Stocks Are Courting a Nasty Surprise on Earnings: Jonathan Levin
To contact the author of this story:
Jonathan Levin at [email protected]
