Key Points

  • Investor sentiment has cracked and is moving toward extreme bearishness; though not quite to levels suggesting a clear contrarian opportunity.

  • Sentiment can be measured by gauging investors’ attitudes; but importantly, by also looking at investors’ behaviors.

  • Households’ exposure to equities suggests muted returns over the next decade.

Although trade remains top of mind for markets, my prior biweekly report was a comprehensive look at that topic (albeit before the latest Mexico salvo); so I’ll tackle a related topic today, which is how investor sentiment has fared through the latest market volatility and weakness.

Let’s start with the indirect message of sentiment being sent by the bond market. My colleague Kathy Jones, who is our Chief Fixed Income Strategist, had this to say in a note out Sunday evening: In comparison to a malfunctioning car, she noted that the “bond market has been flashing warning signs that we’re due for repairs since late last year, but the Fed and other markets were largely ignoring the red lights until recently.” Further, the “drop in real long-term yields is the clearest signal from the market that growth expectations are falling as the market prices in the risk of a recession.”

This has contributed to the inversion (again, like in March) of the 10-year Treasury minus 3-month Treasury yield curve—by more than 20 basis points presently—which has further alarmed investors. In fact, the market now is pricing in interest rate cuts beginning in September of this year; while the S&P 500 is down more than 6.5% from its late-April high.

Impact on investors’ psyche

One of the most widely watched attitudinal measures of investor sentiment is generated by the weekly survey by the American Association of Individual Investors (AAII). It’s a simple weekly poll of their members gauging what percentage are bullish vs. bearish (there is a neutral category as well); and it’s been running continuously since 1989.
The chart below shows AAII’s latest “bull ratio” (the ratio of bulls to bears), and as you can see, it’s fallen off a cliff lately. Fewer than 25% of AAII investors now call themselves bullish, while more than 40% are bearish. It’s one of the lowest ratios in five years.

AAII’s Bulls Pull in Their Horns

Source: Charles Schwab, American Association of Individual Investors (AAII), as of May 31, 2019.