Investment U

The Investment U E-Letter: Issue # 399
Thursday, December 30, 2004

Investor Sentiment Indicators:Ominous Optimism
By Dr. Steve Sjuggerud, Advisory Panelist, Investment U

I spent yesterday in Minneapolis. I’m glad I went. I spent the day with Jason Goepfert (pronounced “Geffert”). Jason studies investor sentiment indicators. That’s all he does. As far as I know, Jason’s website, SentimentTrader.com, is the most complete source of investor sentiment indicators and analysis on the planet (and it’s inexpensive, too. I’ve been a subscriber for years).Jason alerted me to a rare and ominous occurrence in his world of tracking “the crowd.”

When To Follow The Crowd… And When Not To

“The crowd is right in the trends and wrong at the ends” the old Wall Street saying goes. And it’s true.

It’s like real estate right now It seems everyone is making money in real estate these days. The crowd has been correct in the trend. But once everyone has bought, who is left to buy?

That’s what Jason tries to determine have we reached the point where practically everybody has bought? If we have, then it’s time to sell. Or have we reached the point where practically everyone has sold? If we have, then it’s time to buy.

One place Jason looks to size up “the crowd” is the world of investor surveys For example, the American Association of Individual Investors (http://www.aaii.com) polls its members weekly for whether they’re bullish, bearish or neutral over the next six months. And a service called Investor’s Intelligence (http://www.chartcraft.com) surveys investment newsletter writers for whether they’re bullish or bearish.

These surveys tend to be useful when they reach extremes. On the downside, they are far from perfect as investor sentiment timing indicators. But when you see unanimous extremes in optimism across the board (from individual investors and pros), you can bet that a major change in the market is near.

Right now, according to Jason’s website, all four of the major surveys of investor sentiment optimism are at extremes. In other words, people are excessively optimist.

Uh oh. It gets much worse…

The Investor Sentiment Indicator That Called Four Of The Last Six Double-Digit Drops Since 1972

Jason also shared with me an exceptional piece of research about the Investor’s Intelligence survey (the longest running “investor sentiment” survey) that I haven’t seen anywhere else.

It turns out that 2004 will be the seventh year in the history of the weekly survey where bulls outnumbered bears every week of the entire year.

While seven occurrences isn’t that many, the implications are actually pretty terrible After this occurred, every year but two saw a DOUBLE-DIGIT drop in the stock market. There have only been six double-digit drops in the stock market since 1972, when this survey first called it.

Now, no statistics expert will allow us to hang our hats on this – one tiny piece of data, with only seven data points. This is merely an example of one of the many “intermediate-term” investor sentiment indicators that Jason tracks.

What Jason does is compile literally dozens of investor sentiment indicators into a “composite” sentiment score. Ominously, right now, all but one of the few dozen sentiment indicators he tracks are either “neutral” or in the “danger zone.”

It is extremely difficult to use sentiment to time your buys and sells. But investor sentiment indicators are excellent “red flags,” signaling that we are likely very near a change in trend.

And according to Jason’s excellent research, after a nice run-up in stock prices for the last five months, we are likely now very near a change in trend, where stocks don’t perform so well in 2005. Tread carefully

Today’s IU Cribsheet

Here is a chart showing Jason’s 2004 stock market calls from his investor sentiment research:

Good investing,

Steve

P.S. A Follow-Up On the “January Effect”

Investment U Vice President Brian Hunt e-mailed me regarding IU E-Letter #398 – The January Effect: Another Wall Street Scam

“Steve, you’re right about the January Effect not working for the stocks in the Russell 2000 Index. But you didn’t look at microcaps, my specialty. While the median return on the Russell 2000 Index in January since 1994 is negative, the median return on the Wilshire Microcap Index in January since 1994 is 5% – a huge difference!”

Brian continues: “Here’s what I think is going on The Russell 2000 Index is supposedly a small-stock index. However, the median-size stock in that index is $550 million. For reference, that’s a lot bigger than the massive real estate company Cresud you recommend to your readers. That’s not small to me

“Meanwhile, the median-size company in the Wilshire Microcap Index (the index of over 2,000 microcaps) is $59.5 million – nearly a tenth of the size of Russell 2000 companies. This makes these stocks too small for the Wall Street big boys to trade – and perfect for me and my readers. As far as I’m concerned, there still is a January Effect – it’s in the Microcaps.”