Optimism Among Individual Investors Was Historically Low Last Year

The adage of “there’s a first time for everything” applied to the AAII Sentiment Survey last year. Bullish sentiment was below average during all of 2022. Never in the previous 35 calendar years has this happened.

Optimism about the prospect of stocks rising over the next six months was unusually low 38 times last year. Even 2022’s highest bullish sentiment reading, 33.5% on November 17, was notable for how low it was.

Since the AAII Sentiment Survey started in July 1987, there have only been four calendar years prior to 2022 when optimism did not exceed 50% on at least one week. The least optimistic of those four years was 2019 when bullish sentiment topped out at 44.1%. Note that this was nearly 11 percentage points above 2022’s high.

It was a similar story for the AAII bull-bear spread (bullish sentiment minus bearish sentiment). This indicator was below average throughout last year. Its highest reading in 2022, 4.3%, was more than 19 percentage points below 2019’s maximum bull-bear spread of 23.6%.

Before I discuss sentiment’s role as a contrarian indicator, I want to reiterate a point I’ve previously made: Individual investors’ short-term outlooks for the stock market frequently do not go hand in hand with their portfolio allocations. While there are periods when sentiment does influence allocation decisions—particularly during severe downturns—AAII members generally make fewer portfolio moves than the weekly fluctuations in our AAII Sentiment Survey would suggest.

The data from our monthly AAII Asset Allocation Survey illustrates this. Equities averaged 65.7% of individual investors’ allocations last year. This ranks as the 12th-highest annual average since 1988. Surveyed AAII members may have lacked optimism about the short-term direction of the stock market, but they still stuck with their long-term allocations.

What last year’s low readings for optimism did do is change the historical returns for how the S&P 500 index performs following unusually low levels for both bullish sentiment and AAII’s bull-bear spread.

The average six-month return for the S&P 500 following an unusually low bullish sentiment reading in the AAII Sentiment Survey is now 6.6%. The median return for the index is 6.7%. Both remain above the large-cap index’s average and median six-month returns of 4.5% and 5.3% over the period of July 1987 through December 2022.

At the end of 2021, the average and median six-month returns for the S&P 500 following unusually low bullish sentiment readings were notably higher at 8.2% and 8.0%. The historical magnitude of the outperformance decreased over the last 12 months by 1.6 and 1.3 percentage points, respectively. (The S&P 500 returns for all six-month periods decreased by 0.3 and 0.2 percentage points, respectively.)

Following unusually low (negative) readings in the bull-bear spread, the S&P 500 has realized average and median returns of 5.7% and 6.6% over the period of 1987–2022. These returns are 1.2 and 1.3 percentage points lower than they were a year ago.

Even pessimism’s record as a contrarian indicator diminished. The average and median six-month returns for the S&P 500 following an unusually high level of bearish sentiment are now 5.3% and 6.0%. These returns represent respective 0.7 and 1.0 percentage-point decreases relative to a year ago.

Two things coincided to cause the magnitude of outperformance to drop. First, the number of sample periods significantly increased. Last year added 25 new six-month periods for calculating performance following an unusually low level of bullish sentiment (a 12% increase), 27 such periods for the bull-bear spread (a 10% increase) and 22 new periods of unusually high bearish sentiment (a nearly 7% increase). Second, the S&P 500 fell during 22 out of the 26 six-month periods we were able to calculate returns for as of the end of December 2022.

Depending on how 2023 plays out, we could see additional changes in the performance figures. Gains in the first six months of the year should strengthen the link between unusually low optimism/unusually high pessimism and better-than-average/median returns for the S&P 500. Further declines would weaken it. New 12-month return periods will also be added to the data set as 2023 progresses.

Nonetheless, our longstanding suggestions of how to incorporate the AAII Sentiment Survey into your investment strategy remain unchanged. When bullish sentiment and/or the bull-bear spread are unusually low, look at the broader market and economic mosaic. Ask what is occurring that would give your fellow AAII members reason to feel cautious. The answer may reveal whether it makes sense to check your allocation to see if it is still approximately in line with your goals, if any presently held investments are meeting your sell rules or if there are investments that have been put on sale because of prevailing market conditions.