Why You Can’t Always Trust Investor Sentiment Investor sentiment need not always reflect reality, so it is important to be careful before you use that as a guidepost.
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An advanced online trading brokerage can encourage more people to trade. But relying on general investment sentiment may not always give you the right picture of the market. Interesting Findings from the Investor Sentiment Report Seasoned analyst Martin Tillier finds the latest Charles Schwab Retail Investor Sentiment Report interesting, though the overall picture it paints is that investors currently don’t have a particularly good feel about the market. Of the investors surveyed by the report, only 37% believed the current period to be a great time to invest. Tillier points out that this is the lowest percentage since December 2015, and much below the past few years’ average. 52% of the respondents said they were bearish. While that may sound like a gloomy picture, Tillier suggests looking at the past and studying the context of the earlier reports. The survey of December 2015 was released in January 2016. The resultant three years saw the S&P 500 gaining somewhere around 57%. That shows a gloomy outlook that needn’t necessarily indicate things will be that way. The latest time when investors were positive about the market in the report was by 2017-end and, we see the stocks having sunk lower since then. Recency Bias and Headline Bias Tillier says there is something known as the “recency bias” here. This is a phenomenon where you have investors being pessimistic following a big drop. It is a tendency to consider that the trends seen recently will continue, or could happen again. That explains why market insiders sometimes consider investor enthusiasm as a contrary indicator of the market. Retail investors usually buy when the market is at the top and sell when it is at the bottom. But market insiders see it as a sign to
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sell. When investors are fearful after what’s happened, you can’t rule out a bounce at all. There is yet another psychological phenomenon at work called “headline bias”. This was seen in the survey, where the major concern investors expressed was Washington’s political landscape. In fact, 28% of the investors expressed this concern. The global downturn was surprisingly a worry for only 11% of the respondents. Rising interest rates were, even more surprisingly, a concern only for 3% of the respondents. But what was really surprising was that corporate earnings mattered only for 2% of the surveyed investors, despite the fact that corporate earnings are the greatest influence on stock prices. Reality Is Often Different from Investor Sentiment The reality though, Tillier says, is that corporate earnings, rate hikes and global economic conditions are much more important than the goings-on in Washington. Whether Republicans or Democrats are in charge, markets can prosper or decline because what matters is corporate profit earning capability. That capability is, in turn influenced by global conditions and rate hikes. But the sensational headlines about Washington keep coming and influencing our perspectives. This shows that fear is a major factor influencing investor sentiment. Tillier sees Warren Buffet’s age-old advice shining through all this – to be fearful when greed is the overriding investor sentiment, and greedy when fear dominates them.
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