The stock market is very peculiar and often defies logic. Sometimes, when everyone in the market feels one thing, the opposite turns out to be true. That is one of the major reasons why I love it.
The American Association of Individual Investors (AAII) is an independent nonprofit organization founded in 1978 for the purpose of assisting individuals in helping investors become more effective. It has over 150,000 members and I am one of them.
Since 1987, AAII members have been answering the same simple question in a survey each week: "Do you feel the direction of the market over the next six months will be up (bullish), no change (neutral) or down (bearish)?" This week, bullish sentiment was at 19.3%, well below the historical average of 38.5%. Since these are the opinions of an educated and select group of amateur investors, you would think that the measure would foretell a rough six months for equities. But, like in Alice In Wonderland, what is down is up and up is down.
What history shows is that rising pessimism by astute investors actually correlates with higher future stock market returns. Bullish sentiment is below 20% for only the 30th time in the 29-year history of the survey -- and the third time this year. In the 27 occurrences before this year, the S&P 500 has risen 26 times in the following 26- and 52-week periods. According to the AAII, the average gain over 26- and 52-week periods following those occurrences was 12.6% and 19.6%, respectively. In other words, the consensus view of investors was incorrect an astounding 96% of the time.
By the way, the one inconsistency in the pattern was indeed a whopper. In early January of 2008, bullish sentiment was at 19.6% and the S&P fell by 11.7% and 35.7% over the following 26 and 52-week periods, respectively.
These findings reinforce the danger of following the herd in investments and calls into question the wisdom of crowds with respect to the financial markets. Warren Buffett famously wrote that investors should be fearful when others are greedy and greedy when others are fearful. It seems like AAII members are quite fearful right now but you can draw your own conclusions on whether the next few months will be consistent with the AAII Sentiment Survey in the past.
That said, success in the markets over the past 30 years could have been achieved by following the lead of Seinfeld's loveable loser George Constanza, who in a very popular episode of the long-running comedy show was convinced that every instinct he had was wrong, thus doing the opposite was right. Maybe we should all be investing a bit more like "Opposite George" these days. Besides, didn't Seinfeld offer good advice on virtually everything that happens in life?
This article is commentary by an independent contributor. Robert R. Johnson is president and CEO of the American College of Financial Services. At the time of publication, the author held no positions in the stocks mentioned.