This year’s stock market rally has been impressive, especially as its occurred in an environment where individual investors have remained cautious, as evidenced by survey data and fund flow figures, which have shown consistent equity-fund outflows in 2019.
But individual investors are once again wading into the market, indicating renewed bullishness in surveys and flow data released in recent days. These bulls should beware, however, as swings in sentiment can sometimes serve as a contrarian indicator, signaling that stocks may underperform in the months ahead.
The latest E-Trade StreetWise survey , released Friday, showed 58% self-directed investors calling themselves ‘bullish’ on the stock market in the second quarter of this year, a 12 percentage-point increase from the first quarter, when a 54% majority indicated they were ‘bearish’ in their stock market outlook.
“A cloud over the market has been lifted, now that investors aren’t worried about the Fed being too aggressive, and we are also seeing signs of a potential breakthrough on the U.S.-China trade front,” Mike Loewengart, vice president of investment strategy at E-Trade told MarketWatch, arguing that these factors have helped convince his clients that there is room left to run in the current bull market.
He added that the hangover from the nearly 20% drawdown in the S&P 500 SPX, +0.58% in the final quarter of last year stayed with them in the first quarter, causing many to miss out on a least part of this year’s rally.
“It speaks to the emotional challenge that all investors are presented with when it comes to maintaining a longer term point of view,” Loewengart said. “It’s no secret that smaller, retail investors chase performance. That’s a trend that’s unfortunately ever present.”
Indeed, it may be the case that individual investors are chasing performance now, given the market’s rapid first-quarter rise and projections of muted earnings growth in 2019. For instance, a recent survey from the American Association of Individual Investors, also showed investor sentiment improving in the week ended April 10, with 40.3% of respondents predicting that stocks will increase in value over the next 6 months, somewhat above the historical average of 38.5%.
Meanwhile, bearish sentiment, or the belief that stocks will fall over the next 6 months fell to the “unusually low” level of 20.7%, according to a statement accompanying the results, well below the historical average of 30.5%.
But this low level of bearishness is actually something of a contrarian signal for stocks, according to AAII. “Historically, the S&P 500 index has realized lower-than-average (3.8% versus 4.5%) and lower-than-median (4.2% versus 5.2%) six-month returns following [unusually low bearish sentiment] readings,” the AAII said.
Meanwhile, the latest fund flow data from Lipper shows that U.S. equity funds saw a $4.3 billion in inflows in the week ended April 10, versus an $19.7 billion outflow from domestic equity funds from the start of the year through April 3. Also during the week ended April 10, there were $8.4 billion in outflows from cash-like money market mutual funds, according to Lipper, suggesting that investors are moving cash from the sidelines to invest in the U.S. stock market.
