Investor Sentiment: Stepping Back to Hope

"It is indeed beautiful to see a person put out to sea with the fair wind of hope; one may utilize the chance to let oneself be towed along; but one ought never have it on board one's craft, least of all as pilot, for it is an untrustworthy ship-master." ~ Soren Kierkegaard

Are you hopeful or even optimistic about near-future economic and market conditions; or do you see a return to near-past despondency and depression?

As a whole, the feelings of investors are described as something called investor sentiment.  In fact, some investors, especially contrarians, use investor sentiment as a gauge for forming investment strategy; to do the opposite of the herd.  For example, when investor sentiment is extremely euphoric, a contrarian may consider selling stocks; and when investor sentiment reaches panic, a contrarian may consider buying stocks. 

Contrarian strategy considers investor sentiment cycles, which would suggest that the point of maximum financial risk is when the investor herd is irrationally positive; and the point of maximum financial opportunity is when the herd is irrationally negative:

It's not difficult to see that the last Bull market, which peaked in October of 2007, was followed by the investor sentiment (emotions) of Anxiety, Denial, Fear, Desperation, Panic, Capitulation, Despondency and Depression.  This took us to 2009, which began with Hope.

Consider some words from my post beginning that year, 2009:

Hope is not a plan; Hope is not a prudent foundation for success; Hope can not be quantified or measured; and Hope does not translate into any form of currency or something that can be exchanged for a tangible good.

Above all, Hope is not rational; but therein lies its power.

Specifically with regard to market sentiment measures of the collective investor herd, greed and euphoria, which mark the top and opposite end of the market cycle from where we are today, are not rational either; however, similar to Hope, their equal and opposite powers to move financial markets are real and should never be dismissed.

Which Way from Here?

The Hope of early 2009 was followed a few months later by Relief that extended and even touched on some Optimism into early 2010. 

Now that monetary policy and fiscal stimulus appear to be running out of steam, it seems we have stepped backward in sentiment: Optimism and Relief appear to be dissipating, which brings us back to Hope.

As noted previously in this post, Hope is not a prudent plan but it is equally powerful as it is unquantifiable and unpredictable; therefore we stand again at a point of great uncertainty. 

The market sentiment cycle does not progress forward in a predictable pattern, as the image above might suggest.  Sentiment, just like stock prices, does have a long-term forward progression but can take steps backward in the short-term. 

We could now, in the short-term, just as easily go back to Depression and Despondency as return forward to Relief and Optimism.

Where do you think the market sentiment cycle stands today?  Where will it be in three months?  In one year?  Where do you stand personally?

Comments

[Thanks]

I think contrarian investing/speculation is the most reliable trading style.

This is my reasoning. Businesses, fashions, industries, countries, ideas, ideologies, cultural belief, conventions, etc etc change over time, but fear and greed are constants.

All is mutable, except the most basic instincts. And of course the market (Sp&500) always will do the opposite of the herd, in fact the historical price representation of the market is a x-ray image of how the majority lose and the minority win.

"Buy when there´s blood in the street" (Rothschild)

[Kent @ The Financial Philosopher]

Thanks:

I agree; however, I would inject the word "eventually" when you say the market will always do the opposite of the herd!

"The markets can remain irrational longer than you can remain solvent." ~ John Maynard Keynes

As always, I appreciate the comment...

Kent

[Thanks]

yes, "always" was a bad word.

But I will introduce a nuance. I think (and I work with this) that the time the herd can remain irrational in the upside, can be a very long time, cause greed is a slower emotion than fear. When people is greedy they are couting the new coins in the pocket everyday.

Also, irrational behavior to the downside are very quick, fear is panic, fast, people run.

So, in my opinion, cause these two emotions are of different speed is more reliable to buy the market at a bottom than the market at a top, cause detect panic is more evident than detect greed and complacency.

Regards

[Kent @ The Financial Philosopher]

Thanks:

Agreed! On your note, here's another quote:

"Fear tends to manifest itself much more quickly than greed, so volatile markets tend to be on the downside. In up markets, volatility tends to gradually decline." Philip Roth

[Jan]

Personally,
I think the big people on wall street make their money on either side of the coin. They make the most when we all buy and sell.
Sitting tight and hoping the bed bugs don't bite. I don't NEED the money for five more years- but it will be painful to watch despair reign on the heels of Glen Beck. (He sells gold.)

[Guild Wars 2 gold]

I fully agree with the author's argument.Fear tends to manifest itself much more quickly than greed, so volatile markets tend to be on the downside. In up markets, volatility tends to gradually decline.

[Kent @ The Financial Philosopher]

Jan & Guild:

Yes. The institutional investors look to make money when the investor crowd moves (in either direction). In essence, the big players use the smaller investors as tools.

By not allowing emotions to govern your investing behaviors, you cease to be a tool for money and the markets; you are enabled to use money and the markets as a tool for your own life...

[Jim Cosgrove]

Three months? One year?
I don't have a clue. Prices fluctuate.

Personally though, I think we're in a period not unlike 1929-1949 or 1966-1982. I have a "glass half full" view; the platform for the next (global) wave of prosperity is being built. This is going to take a while, but in 10, 15, 20 years I think we'll look back and ask, "Why didn't I risk up?" "What was I so afraid of?"

Short-term, anything can happen. Long-term I'm Hopeful to Optimistic.

[Kent @ The Financial Philosopher]

Jim:

My sentiment closely matches yours. It seems we have three to six months to scrape the bottom (or find a new one). From there, a new foundation for the next growth phase will take years to create and build upon.

As you said, "short-term anything can happen. Long-term I'm Hopeful to Optimistic."