Investor sentiment reached extreme levels of fear amid the January market debacle, according to the American Association of Individual Investors (AAII). The ratio of bearish to bullish investors exceeded 200% (two bearish investors for every one bullish) in January, and still stood at 187% at month-end. This is a level of fear rarely seen (see chart). The last time sentiment was this bearish was in April of 2013, and it previously reached it three times 2008-09.
It’s often said that “the market climbs the wall of worry” – sentiment tends to be a contrary indicator. When investors say that they are bearish, they have likely already sold stocks, and need to buy them back when calm returns. That’s why high bearishness tends to be a net-positive driver for the stock market: it tends to precede higher market returns (and vice versa). Of course, this is not the only factor, we need to account for other important data that tend to influence equities, including valuation and economic factors.
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