Investor sentiment measures have historically been used as contrarian indicators—meaning one would expect the market to do the opposite of what the data was saying. Today’s blog focuses on one gauge of market opinion—the AAII Sentiment Survey—and its potential use as a contrarian indicator.
Table of Contents
AAII Sentiment Survey Introduction
Sentiment describes a group of people’s opinions, emotions, or views. In investing, sentiment can dramatically influence the prices of securities, especially in the short term. We can give thanks to our rational and irrational emotions for that. However, haywire emotions, fear, and greed can cause us to do some questionable things. When emotions take hold, we see investors buying high and selling low. Conversely, with markets rising, many rushes in to buy, further pushing up prices, and FOMO is activated.
Conversely, many rush out when prices start to tank due to fear. Wise investors load up when the price is low. Only, of course, if the indicators look good. Predictably, stock prices generally go back up, and we see investors getting back in.
You may recognize this market myopia as being more acute on the downside. Behavioral economists have a name for this. They call it “myopic loss aversion.” But, again, the Force is strong in this one. An AAII sentiment survey helps measure where investors are at.
5-Second Takeaway
- Sentiment describes a group of people’s opinions, emotions, or views.
- Market sentiment refers to the overall attitude of investors
- Bullish sentiment is the expectation that stock prices will go up in the next six months
- Neutral sentiment suggests a high level of uncertainty among investors
- Bearish sentiment is the expectation that stock prices will go down in the next six months
- Market sentiment has been bearish for the 52nd time out of the past 55 weeks.
You can also check out our SentimentTrader review for more sentiment-type content, like an AAII sentiment survey.
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Forecasting Sentiment
The price of a specific security is the total sentiment of all market participants. Hence, if you could forecast changes in sentiment, you’d likely have the upper hand in determining how the market will do. The problem with sentiment is that it is only known after the fact. Hindsight is truly 20/20.
Market sentiment—the summation of all expectations for the market as a whole—often directly reflects where the market has been, not where it is going. When market sentiment is low, the majority believes the market will fall, while high market sentiment means that the majority feels the market will rise in value.
However, history shows us that, more often than not, the market will go against the majority. Extremely bullish sentiment levels often come after substantial market run-ups when investors fully invest.
How Do We Measure Market Sentiment?
There are a few different ways to measure market sentiment; a few of them are listed below:
- Surveys of individual and professional investors
- Analyzing trading data (i.e., looking at block trades., the level of short interest
- I was monitoring the media for any trending stories of major publications.
- AAII Sentiment Survey
The AAII Sentiment Survey
Since 1987, The AAII Sentiment Survey has been a weekly survey of its members that asks if they are “Bullish,” “Bearish,” or “Neutral” on the stock market over the next six months.
Conducted online from Thursday at 12:01 a.m. until Wednesday at 11:59 p.m., market sentiment data is compiled and depicted above for individual use.
Hindsight bias tends to happen when we rely on historical data to decide. The AAII sentiment survey hopes to give investors a forward-looking market perspective.
Once a week, members of AAII can vote online at the Member Surveys area of AAII.com. Results are compiled and published on Thursdays on the AAII Web site and Barron’s.
Who are the AAII members? According to the AAII website, the average AAII member is a male in his late 50s with a graduate degree. Furthermore, over half of the AAII members have an investment portfolio of at least $500,000. The survey represents a small group of hands-on, active investors. Because of this, it’s important to remember that the data might differ from the masses.
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AAII Sentiment Survey Numbers
Regarding the AAII sentiment survey, investors should consider all three levels, although individual readings also provide information. The percentage for each category should be compared to its historical high, low, and average levels.
Bullish Percentage: Counterintuitively, having a high percentage of bullish responses may mean too many investors are optimistic about the stock market. As a result, too many people may own the security, and no more buyers to take higher prices.
Neutral Percentage:
Investors have high uncertainty if we see AAII sentiment percentages with many neutral responses. We can also assume if investors aren’t purchasing securities, they’re likely building up their cash supplies.
Conversely, low neutral percentages indicate investors are more certain about the stock market’s direction. Envision them as those sitting on the sidelines waiting to strike when the time is right.
Bearish Percentage: If the percentage of bearish responses is high, there may be too many bearish investors. This implies that investors have already reduced exposure and are ready to start buying again.
Historical Performance
One can easily see all the weekly readings of the AAII Sentiment Survey in the Member Surveys area of the AAII website. For example, if you head on over to Table 1, you’ll see a summary of sentiment statistics from the market period of July 24, 1987, to September 2, 2004.
Let’s consider an example and interpret the numbers.
- 38.8%: Bullish Sentiment (average)
- 38.0%: Median (mid-point) value
- 33.4%: Neutral sentiment
- 27.9%: Bearish Sentiment (average)
- 27%: Median (mid-point) value
So, what do all these numbers mean? First, it meant that close to two-fifths of AAII members believed the market would rise in the next six months. Conversely, approximately one-third believed the market would be flat in the next six months. And a little more than one-quarter thought the market would decline in the coming six months.
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AAII Sentiment Survey as a Contrarian Indicator
Did you know that the Sentiment Survey is a contrarian indicator? This means that Above-average market returns have often followed unusually low levels of optimism, while below-average market returns have often followed unusually high levels of optimism.
While little may be gleaned from investor sentiment changes, identifying extremely positive or negative sentiment levels offers a glimpse of where the markets may be headed.
If you look at the charts online, when sentiment reached overly bullish levels, the markets normally responded negatively in the following months. Conversely, the market tended to rise when members became overly bearish.
As of December 8, 2022, pessimism regarding the short-term direction of the stock market rose to a four-week high. On the other hand, optimism stayed around the same level, while neutral sentiment fell but remained above average.
Bullish sentiment, or the expectation that stock prices will increase in the next six months, rose 0.3 percentage points to 24.7%. However, although bullish sentiment increased, it stayed below the historical average of 37.5% for the 49th consecutive week.
Neutral Sentiment
Neutral sentiment is the expectation that stock prices will stay about the same by 1.7 percentage points to 33.5%. Historically, the average neutral sentiment is 31.5.
Bearish sentiment, expectations that stock prices will fall over the next six months, went up 1.4 percentage points to 41.8%. What’s even more alarming is that it’s the 52nd time out of the past 55 weeks that the sentiment is bearish. Moreover, it’s back to unusually high levels for the first time in four weeks.
You’re left with the bull-bear spread when subtracting bullish from bearish sentiment. Historically, the average is 6.7%; currently, it’s -17.1%
Why are investors bearish? For many reasons. Worries about inflation, interest rates, employment, and corporate earnings continue to plague investors, causing many to be cautious and hesitant.
Final Thoughts: AAII Sentiment Survey
Even though investor sentiment may be used as a contrarian indicator, it would not be wise to base all your investment decisions upon it. Indicators such as this are best used in tandem with others so that you receive confirming signals of potential market movements.
Sentiment serves as an additional tool when making investment decisions. Paying attention to the AAII sentiment survey isn’t a bad thing.
Lastly, even if you do not use sentiment data as an indicator, it is good to be mindful of it. Getting caught up in the herd mentality is easy as investors become overly bullish or bearish. However, as we have shown, you might get trampled if you run with the herd.
