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A Look at Sentiment Surveys


So...if they DO what they SAY, why are you NOT DOING what they're NOT saying?


My Dad likes to play games with telemarketers. Sometimes he'll play a Tickle Me Elmo doll whenever they call and ask him a question, or give his answers in "French" (he does NOT speak French).

The funny part is that some of the callers take his answers seriously, particularly the college kids reading from a script who call to find out whether he's voting Democrat or Republican in the next election.

Because of people like my Dad, these folks have a heck of a time trying to gauge the real sentiment of the public, which is why some of their margins for error can be so wide. Whether it's politics or equities, despite these difficulties pollsters continually try to gauge our level of interest in the subject.

Today we're taking a look at sentiment surveys.

What is it?

Like I noted above, a sentiment survey is a simple poll conducted by an organization interested in knowing our level of commitment to a particular cause, in this case the stock market. Some of them poll the same demographic time after time, while others get their responses from a continually evolving sample.
Surveys that monitor the stock market report their results in different ways, and ask different questions, but usually the end result is a figure that tells us what percentage of the sample expects stocks to rise over the next one to six months.

Generally, investors become more bullish as stocks rise and less so as they fall. When a large majority of them share the same opinion, in true contrary fashion the stock market tends to prove them wrong by moving in the opposite direction. For this reason, traders follow the survey to get a feel for how extreme current opinion is, and if it is likely to affect future market performance.

Why should we follow it?

Many of the surveys have a relatively long history, and their results are either posted in national publications or otherwise widely disseminated, so they are easy to follow. Over time, it becomes evident what can be considered an extreme for each survey, and despite the varying methodologies and samples, extremes in the surveys have proven effective at highlighting when risk is high or low in the stock market.

There have been academic studies that dispute the usefulness of this type of analysis, but anyone who has ever tried to actually trade based off of an academic paper is probably no longer trading. Over their history, sentiment surveys based on public opinion have an admirable track record at highlighting market extremes, and are about as effective as any other market-timing device.

What are the challenges in using it?

The biggest hurdle these surveys face is that most of them ask what our opinion is, not necessarily how we are positioned. Either way, their accuracy depends on how honest the responders are. If they ask what someone's opinion is, that doesn't mean that they have acted on those beliefs. 100% of them could SAY that they're bullish, but if only 20% have acted on that, it makes a big difference.
Some of the surveys have exceptionally small sample sizes, and likely wouldn't hold up to robust statistical analysis. The American Association of Individual Investors, for example, typically had around 90 of its members responding to its survey, out of a total population of around 150,000.
While some surveys have daily updates, that's probably overdoing it as most investors don't change their minds that often. Weekly is usually good enough, and most follow that schedule. If there are large intra-week changes in the market, though, these surveys won't reflect that until perhaps well after the fact. In addition, some don't report their results right away, so there can be a delay in us getting the information.
What does it look like?
What's it suggesting now?

In November, we saw true extremes in bullish sentiment across the major publicly available sentiment surveys. There was an excess of truly euphoric feelings about stocks, and while the market certainly didn't fall apart afterwards, the gains have been stop and go.
This data is typically more effective at spotting bottoms in an uptrend and tops in a downtrend, so when we see optimistic extremes in a positive market, it's usually best at indicating those times that gains will slow down, and not necessarily a good time to sell everything or short the market.
We've seen exceptionally unusual behavior lately as investors have become significantly less bullish while the market rises. I wrote about the implications of this earlier, and my thoughts on the subject have not changed. The precedents of what we're seeing now – increasing risk aversion during a positive market – have often led to short-term gains, but invariably lead to trouble in the intermediate-term.
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No positions in stocks mentioned.

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