The word sentiment usually refers to feelings and emotions and is usually used to measure public opinion. The term originates from the French “sentement”, first appearing in the 17th century. Historically, public opinion was shaped in coffee houses or the exclusive “gentlemen's clubs”, and had a profound impact on political and social discourse. William Shakespeare once referred to public opinion as the "mistress of success”, underlining how influential public opinion is. I also consider sentiment as an important ingredient to investment strategies.
When someone asks me “What is the secret to a successful investment?” I pretty much think of: “just buy something before everyone else does lol.”
Pretty much everything in the world gradually gets more expensive with time. It’s not just houses, rent and cars, but also technology and new sophisticated devices, furniture, stuff you buy from amazon, clothes, McDonalds, eggs, meat, vegetables, everything gets more expensive as time goes on. This upward creep is known as inflation or “devaluation of money”, depending on which angle you’re looking at it from. In reality, things don’t really increase in price, rather than our money is being devalued.
Here's a shocker: a dollar from 1969 has been so outpaced by inflation, it would need to be $8.39 today to match its past buying power. The cumulative U.S. Dollar inflation since 1969 adds up to 739%(!), with an average inflation rate of 4% per year.
A simpler graph of the same scenario shows that a 1969 dollar is now worth just 0.11 cents.
However, the interesting thing about how everything “appreciates in value” is that you can also increase your wealth, almost as quickly as you spend it. And that happens through investing in desirable assets.
For example, investing just $1 in the S&P 500 in 1969 would worth $199 today, with a cumulative return on investment of 19,795%(!!), an average of 10.2% per year. Even when you take inflation into account, you're still looking at a 6% return each year.
So why isn’t everyone investing in the S&P 500 and just … wait? Well, it seems to boil down to patience — or a lack of it. People either can't wait it out for the long haul, or they get shaken up by market dips and bail too soon, especially during rocky times like the ones we're in now.
The Tribe
Humans have a deep-seated need to fit in, to be part of a group that gives us a sense of security. This instinct drives us to adopt what we see as 'normal' behavior, based on those around us. Investors are no different — many peek over their shoulders, taking cues from their peers on when to buy or sell.
I'm all for leaning into sentiment when making investment decisions. I recently wrote a detailed report on how hedge funds are weaving market sentiment into their strategies. But you don't need to be a pro to tap into this wisdom. There are plenty of available sources online that gauge market sentiment which you can easily find. Or, simply, look around you. We live in the most digitalized period of humanity’s existence where sentiment and public opinion can be measured with a quick scroll through twitter or reddit.
I'll be the first to admit, I sometimes get caught up in Reddit's quick consensus-building. There is something about the platform’s voting system that makes establishing consensus and measuring sentiment so quick and effortless. But this system may also cause you to fall into the trap of following an “echo chamber” or just completely destroy your critical thinking skills, causing you to blindly follow other’s opinions.
Therefore, the purpose of this article is to propose investing in a “contrarian” manner. Simply put, contrarian means going against the grain, by investing when market sentiment is low and staying put (or taking profits) when sentiment is reaching peak excitement levels.
Kenneth Fisher put it perfectly when he said:
“Indeed, when people lose confidence as consumers, they should regain it as investors.”
Bold
Kenneth Fisher's insights on the connection between investor sentiment and market returns broke new ground in investment strategies. He found a negative and statistically significant relationship between investors' sentiment and subsequent stock returns. Research is now being conducted using LLMs such as ChatGPT to measure sentiment and forecast market returns, and the results are truly groundbreaking.
This relationship between sentiment and market returns perfectly explains why at the present time, economic data and the stock market movements are often contradictory. Right now, we're in a situation where the Federal Reserve and other central banks are trying to cool down economies that are too hot from years of low interest rates and lots of spending. Even when we see strong economic numbers like the U.S. having solid growth or inflation slowing down in Europe, it can actually lead to tougher times ahead. Central banks will likely tighten up money policies, which can lead to job cuts and people spending less. We're already starting to see less spending, even if the news says otherwise, especially among the middle and lower income groups who are still dealing with high prices.
But remember: The market is forward looking. This means that current available information is not enough to predict future returns. What matters is the anticipated trajectory of the economy as a whole.
When you think about it, it makes sense to buy something when it's cheap, right? Sentiment in the market goes back and forth, but when it starts to get better, usually prices go up. As Sam Stovall, the investment strategist for Standard & Poor’s, once stated:
“If everybody’s optimistic, who is left to buy? If everybody’s pessimistic, who’s left to sell?”
Last month, JP Morgan pointed out that buying when everyone else is down on the market can pay off. Their research showed that if you bought when consumer sentiment was at its lowest, you could see a 25%(!) return after a year, compared to just 4% if you bought when everyone was feeling good about the market. A 6x return increase just by investing when everyone else was skeptical.
Bloomberg also found that when their Sentiment Index drops below 0.5, which results in “panic mode”, major indices such as the US Russell 3000 and the EU STOXX 600 recoup their initial losses and outperform the “less risky” S&P 500 in a period of around 3-12 months.
Now some might say that sentiment analysis suffers from classic “hindsight bias”, as sentiment is incredibly hard to predict in advance. My argument is that “predicting” investor sentiment isn’t about seeing into the future with perfect clarity; it’s about piecing together a puzzle using pieces that everyone has access to, but not everyone can fi together. Investors who can interpret these signs may find themselves a step ahead, capitalizing on sentiment shifts before they fully manifest in the market. At the end of the day, we all have access to the same information, but how we react to it or use it is what allow some to stand out. Here are some of my favorite resources:
1. Conference Board’s Consumer Confidence Index
2. University of Michigan Consumer Sentiment Index
3. Goldman Sachs Sentiment Indicator and Investor Positioning
4. Daily News Sentiment Index by the Federal Reserve Bank of San Fransisco
*All of the above resources are free, publicly available and updated on a monthly or daily basis.
Parting words
Reflecting on my past few articles, you might have picked up on a certain pessimistic and bearish stance on the broader economic landscape and market trajectory. I’ve been encouraging people to buy Bitcoin for the past 1.5 year, as soon as it fell below the $30,000 mark in June ’22, all the way down to $16,000. Now Bitcoin is up close to $35,000 again. Needless to say, Bitcoin us up by more than 100% YTD. Parallel to this, my sentiment towards equities has been somewhat sceptical, particularly as I watched Nvidia's valuation soar from $250 to $500 between May and August, while the S&P 500 sunk by 11% from July since its low in late October.
This market behaviour, set in the middle of a global rate hiking cycle, has created unrealistic expectations. A surge prompted by a handful of stocks (Nvidia, Microsoft, Meta, Google etc.) fuelled by the "AI gold rush" has left investors thinking another bull market was imminent. Guess who made the most money during these past couple years? The contrarian. Those who had the courage to go against the grain and buy when everything was selling off and those who realized when the hype reached its breaking point and took some profits.
My point is: human psychology has a profound influence on market dynamics, and it shouldn’t be underestimated. While most experienced portfolio managers are concerned about quantitative strategies and fancy algorithms, it's those who decode the behavior and sentiment of the average investor that consistently outperform. A good investor understands both numbers and narratives.
Therefore, I urge investors to synthesize both quantitative sources (credible news platforms, analysts, researchers) and “qualitative” insights (the sentiment pervading people around us). Be bold, be a contrarian, question everything.
“In good times skepticism means recognizing the things that are too good to be true; that’s something everyone knows. But in bad times, it requires sensing when things are too bad to be true. People have a hard time doing that. The things that terrify other people will probably terrify you too, but to be successful an investor has to be stalwart. After all, most of the time the world doesn’t end, and if you invest when everyone else thinks it will, you’re apt to get some bargains.” - Howard Marks, Co-CEO of Oaktree Capital.