The Best Buying Opportunities are When Investor Sentiment is Low

A lot of people say they want to invest against the ‘herd’.

But it’s a lot easier said than done…

You have to have courage in spades to think and act differently in the investing world.

For most, it’s much easier just to parrot the talking points of the day. You feel comfortable in the crowd of accepted opinion.

It’s always been thus…

In the 1841 classic book, Extraordinary Popular Delusion and the Madness of Crowds, Charles MacKay wrote:

Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one.

Such group think was as common to MacKay’s era as it is now. It works in both directions — up and down.

And then, as now, it’s often wrong.

Which brings me to the state of the current markets…

What do you think the prevailing wisdom of the crowds is right now?

I’ll show you an indicator that measures just that in a moment.

Then you’ll have to decide if you have the courage to go against it…

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So, you want to be a contrarian investor, do you?

Investor sentiment is falling…

In fact it’s now at a low only seen a handful of times since market lows back in 2009.

Check out the chart here:

This chart shows the results of a weekly sentiment survey by the American Association of Individual Investors (AAII).

So, we’re talking about ‘ordinary’ punters like you and me, rather than the highfalutin big wigs on Wall Street.

As you can see, the crowd is worried.

And maybe for good reason…

You only have to open a newspaper or click onto a finance website to see ‘bad news’ finance stories abound. From Brexit to trade wars, to central bank interventions amid declining global growth.

The latest bit of bad economic news came from the US last week…

Retail sales fell in September, suggesting the American shopper was finally starting to feel the pain of global economic turmoil.

The danger here is the flow-on effect to other parts of the economy.

As reported on CNBC:

U.S. retail sales fell for the first time in seven months in September, raising fears that a slowdown in the American manufacturing sector could be starting to bleed into the consumer side of the economy.

Moody’s chief economist chirped in as well, saying:

I think risks are awfully high that if something doesn’t stick to script then we do have a recession.’

But wait a second, didn’t we say at the start that the crowd was usually wrong?

Well, that’s what the next chart is going to suggest.

Before I showed you that I wanted to expose you to the full brunt of fear. Because if you decide to be a contrarian investor or trader, this is the feeling you will be battling…

Feel the fear, take the plunge?

The below graph is going to show you how the stock market reacted after previous pessimistic AAII sentiment readings.

A sea of green!

It would seem that the old investing adage of ‘buying in gloom, selling in boom’ would’ve seen you making some nice returns in this current 10-year bull market.

If you’d had the courage to ignore the herd…

In other words, the best buying opportunities have been when investor sentiment is lowest.

Charles MacKay wouldn’t have been surprised at this outcome.

Of course, there’s no guarantee this will stay true.

Perhaps the economy is as bad as the headlines read, and for once the crowd has got it right?

Funnily enough, a 2004 book, The Wisdom of Crowds suggested MacKay perhaps had it wrong and group decisions were better than individual ones in certain circumstances.

The key to crowd wisdom it would appear (over mad ones) is the independence of thought by the individuals in it.

Once they lose their independence of thought, the crowd can become mad.

For you it all means this…

If you want to be a contrarian investor, you have to form your own judgments. You can’t be swayed by group think and sentiment. But you can’t go against it just for the sake of it either.

There are no shortcuts here.

Do your homework, make up your own mind, then place your bets…

Good investing,

Ryan Dinse,
Editor, Money Morning

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Ryan Dinse is an Editor at Money Morning.

He has worked in finance and investing for the past two decades as a financial planner, senior credit analyst, equity trader and fintech entrepreneur.

With an academic background in economics, he believes that the key to making good investments is investing appropriately at each stage of the economic cycle.

Different market conditions provide different opportunities. Ryan combines fundamental, technical and economic analysis with the goal of making sure you are in the right investments at the right time.

Ryan's premium publications include:

Money Morning Australia