Investor sentiment surveys are powerful tools that provide the ability to gauge the expectations of other investors. Survey results can be noisy, but when sentiment is pushed to an extreme, it can be useful as a contrarian indicator. Recently, at least one widely followed survey has begun to indicate excessive optimism.

Back in April, we wrote about the AAII Investor Sentiment Survey. In short, this survey polls individual investors and asks them if they are bullish (positive outlook) or bearish (negative outlook) on the stock market over the next six months. For more detail on the survey, see our original post (here).

At the time of our original post, sentiment was flashing an excessively pessimistic level. The pain of the market selloff that lasted until late March was still fresh, and there was considerable fear the market could dive once again. Flash forward to today, and we have swung to the opposite end of the spectrum, with sentiment now in overly optimistic territory. The shift toward positive sentiment was accelerated by a few developments in early November, including the alleviation of much of the election uncertainty and the publication of better than expected efficacy rates for several potential Covid-19 vaccines. These developments sparked a substantial rally in stock prices, particularly within the industries that have been under the most pressure during the pandemic.


Source: American Association of Individual Investors 1/3/2013 – 12/3/2020. The bull versus bear spread represents the percentage of respondents that are bullish less the percentage that are bearish. 7.2% has been the historical average back to 1987. Extreme optimism (pessimism) is represented as 1 standard deviation above (below) the average. 

Two major takeaways from our post in April were:

  1. Investor sentiment typically reflects what has just happened. High pessimism followed periods where the market had negative performance, while high optimism followed periods where the market had above-average performance.
  2. When sentiment hits an extreme level, the market tends to reverse. Excessive pessimism has often been followed by above-average returns, while excessive optimism is typically followed by below-average returns.

While it won’t always be the case, these two takeaways match up perfectly with the survey we wrote about in April. The return on the S&P 500 three months leading up to that survey was -14.1%, while the return in the subsequent three months was +15.8%. Additionally, the return in the three months leading up to the most recent (and excessively optimistic) reading has been +8.4%, which is well above average.

Investor Sentiment versus Market Returns

Source: Sentiment from American Association of Individual Investors, from 12/31/1987 – 12/03/2020. Returns from Morningstar Direct and are not annualized. 3 month periods are estimated based on survey release dates (weekly).

So why is sentiment a contrarian indicator? When sentiment is high, so are investor expectations. If sentiment gets too high, unrealistic expectations can lead to a scenario where even a good outcome is not enough, resulting in falling stock prices. The same is true with pessimistic sentiment. When expectations are too low, even a relatively poor outcome can exceed expectations and generate positive stock movement.

As we approach the end of the year, investor sentiment has pushed to the highest level since late 2017. Additionally, valuations have continued to climb higher, particularly for large-growth stocks. Historically, this has not been a good recipe for strong returns.

It’s important to note that even when sentiment is overly optimistic, the stock market has still delivered a positive return on average; it just tends to be lower than normal. Additionally, investors who tilt their holdings towards small and value-oriented stocks don’t have as much of an issue with high valuations.

Although the survey results shouldn’t send investors running for the exits, it is probably a good time to temper expectations for returns in the near-term.


  • Last Friday, the Bureau of Labor Statistics published its monthly jobs report, which is one of the most widely followed pieces of economic data. According to the report, the economy added 245,000 jobs in November, missing the Wall St estimate of 460,000 by a wide margin. Under normal circumstances, a 245,000 gain in employment would be a great print. Unfortunately, we are not in normal circumstances, and the figure represents the slowest rate of job gains since the labor market recovery began in May. A couple of factors likely led to the disappointing figure. First, government employment declined by nearly 100,000 as work on the census winds down. Second, the government response to the current wave of Covid-19 infections has slowed hiring at bars and restaurants, which had been rapidly rehiring. Finally, the expectation of more online shopping for the holiday season led to less hiring in retail. The unemployment rate fell to 6.7% from 6.9% in October, but that was largely a result of workers dropping out of the labor force.
  • This morning news broke that the FDA has concluded the Pfizer/BioNTech vaccine, the first to be considered for U.S. distribution, “met the prescribed success criteria” in clinical trials. According to the WSJ, the FDA could greenlight distribution of the vaccine as early as this weekend. Across the Atlantic, the U.K. began administering the vaccine to its citizens today, making it the first Western country to do so. After trading slightly lower yesterday and again this morning, the U.S. stock market has moved back into the green following the announcement.
  • This will be a relatively light week for economic data. Look for jobless claims and inflation data on Thursday and consumer sentiment on Friday.



  • Tesla Is Watching Its Stock Prices Too (WSJ)
  • Employment Growth Slows Sharply in November Amid Coronavirus Surge (CNBC)


  • I Started Trading Hot Stocks on Robinhood. Then I Couldn’t Stop (Jason Zweig)
  • The reasonable Optimist (Morgan Housel)


  • FDA Says Pfizer-BioNTech Vaccine Meets Success Criteria (WSJ)
  • 5 Big Picture Trends Being Accelerated by the Pandemic (Visual Capitalist)


Source: MarketWatch


Source: Morningstar Direct.

Source: Morningstar Direct.



Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

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Josh Jenkins is the Chief Investment Officer at Lutz Financial. With 10+ years of relevant experience, he specializes in assisting clients with portfolio construction, asset allocation, and investment risk management. In addition, he is responsible for portfolio trading, investment research and thought leadership for the division. He lives in Omaha, NE, with his wife Kirsten.

  • Asset Allocation
  • Portfolio Management
  • Research & Data Analytics
  • Trading System Operation & Execution
  • Chartered Financial Analyst®
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
  • BSBA, University of Nebraska, Lincoln, NE

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