Feeling Panicked? Think Again

There are hundreds of pieces of data that stock market prognosticators use to predict its direction. Many, like industrial output, unemployment, inflation, orders, etc., relate to whether the current economic cycle is moving upward or downward. Others, like money supply and interest rates, reflect monetary policy. Still others, like market P/Es, dividend yields and earnings yields reflect valuation. But the singular most predictive indicator with respect to market performance is sentiment.

Sentiment is the indicator that shows optimism for future market performance. If I were forced to rely on only one (and I follow twenty-one), that is the one I would pick.
The sentiment indicator is a negative indicator. If you’re a math geek, there is an inverse relationship between the level of market optimism and its probability of moving down. If you’re a regular person, you should follow the opposite of what this indicator says. If it says, “We LOVE the market, and want to buy LOTS of stock,” be very wary indeed. If it says, “We’re all going to the poor house,” take heart. This is a positive indicator, and is, as I said before, one of the most reliable – and predictive – of any piece of information available.

Here is a history of the sentiment indicator over the last ten years. This number indicates a percentage of positive, or “bullish,” sentiment.

• 1998 47.376%
• 1999 52.554$
• 2000 51.012%
• 2001 48.238%
• 2002 44.398%
• 2003 51.042%
• 2004 51.979%
• 2005 57.851%
• 2006 59.538%
• 2007 62.985%
• 2008 29.661%

Note that the “Internet bubble” burst in 2002, causing a market correction and a corresponding downturn in sentiment to 44.398%, the lowest number in the last ten years. The stock market, measured by the Standard & Poor’s 500 Index traded at 989.82 at the end of June that year. In June 2007, with sentiment at its high over the last ten years, that index traded at 1505.72.

June 2002 would have been a good time to buy. June 2007 would have been a good time to take some profits. Where are we now? 29.661%, and the index is at 901.84. Some, me among them, would consider this to be a screaming buy signal.

There is one other piece of information that should be considered when deciding whether to buy or sell in this environment. The stock market is a “discounting mechanism,” which means is that it looks to the future, and prices accordingly. How long into the future does it look? Usually about six months to a year.

Most people who don’t live under rocks agree that the US economy is probably going into recession. Unemployment is up. Housing prices are down. The stock market is down. Big. And people are curtailing their spending, because they’re nervous.

While recession in its technical definition – two consecutive quarters of contracting Gross Domestic Product – has not begun, most people believe that the last quarter of this year and the first quarter of next year will not show net economic growth. Most people believe, that with the extraordinary steps taken by the Treasury Secretary and Federal Reserve Chairman, growth should resume in either the second or third quarter of next year.

So, in consideration of the fact that the sentiment indicator is at extraordinarily low levels, the market is a discounting mechanism, and economic turnaround is predicted from seven to nine months in the future, a reasonable person would be considering whether to buy – and not sell – in this environment.