Today’s headline on Yahoo Finance “July Consumer Sentiment Worst Since March 2009” caught my eye. What they are referring to is the Thomson Reuters/University of Michigan consumer sentiment index, which is a survey of consumers. This got me thinking about investor sentiment.
Investor’s Intelligence publishes a weekly index of sentiment derived from investment newsletters, with data going back over 40 years. Some of our clients may be familiar with Jeremy Siegel’s book Stocks for the Long Run. In this book, Professor Siegel used this data to derive his own index of sentiment. He then measured subsequent stock market returns for the period 1970-2006, as well as for individual decades. The results vary by time period, and there is no guarantee that future results will be similar to what has happened in the past. However, some interesting relationships emerge. I like to look at as much data as possible, so I will focus on the entire 1970-2006 period:
When sentiment went above 80%, subsequent returns over the next 12 months were negative. When sentiment fell to 50% or below, subsequent 12 month returns ranged from +13.43% to +20.74%.
Investor sentiment is a funny thing. The human brain is wired to do the wrong thing at the wrong time in the stock market. I start to get worried when investor sentiment levels are high, and feel better when they come down a bit as they have recently. Sentiment is currently around 59%. This is down from a 2011 high early in the year of almost 80%, and up from a low of less than 30% at the recent stock market bottom in early 2009.
There is always something to worry about. Currently it is the debate over raising the debt ceiling in the US and the continuing credit issues in some of the Euro zone countries. We are confident that these issues will get resolved. Something else will then come up, whether inflation or deflation, a geopolitical event, a natural disaster, or something completely unpredictable.
We are encouraged by rising earnings and dividends in the US stock market. Consensus earnings for 2011 are about $98 for the S & P 500. This equates to a price/earnings multiple of about 13.4, below the historical average of around 15. Many companies are increasing their dividends as well. Stock prices eventually follow rising earnings and dividends, and we believe the current combination of reasonable valuations with reasonable levels of sentiment are a tailwind for long-term returns.
Bill Hansen, CFA
July 15, 2011