Surveys Show Warmer—But Still Mixed—Sentiment

Are you feeling happy these days? You aren't alone. As markets clock new highs, some widely watched investor sentiment surveys report widespread cheer-with one showing investors at their sunniest since September 2000. Yet before you fear euphoria has set in, another survey shows fund managers feeling a bit more blue. What to do? Looking at all the surveys and putting them in historical context, it seems fair to say investors are broadly more optimistic-as you'd expect in a maturing bull market. But pockets of skepticism indicate investors haven't run out of worries, suggesting to us folks can get even happier before sentiment spirals out of control.

Here is a more detailed look at the surveys in question. First up, the weekly American Association of Individual Investors (AAII) survey, which reports 41.3% of investors were bullish, 36.7% were neutral and 22.0% were bearish as of September 13-above the historical average of 38.5% bullish since July 1987.

Meanwhile, the Wells Fargo/Gallup Investor and Retirement Optimism Index for August hit a 17-year high. The 98-point rise in since February 2016 is the highest rise in the index's 20-year history. Moreover, 68% say they are "optimistic" about the market over the next year-matching the record high from December 1999/January 2000-and 25% say they are "very optimistic," a record high. Yet institutional investors seem more skeptical, according to the September Bank of America Merrill Lynch Fund Manager Survey. The number of managers hedging against a possible correction posted its biggest jump in 14 months, and they're holding a "higher than average level of cash." So while individual investors may be turning more bullish, institutional investors seem to be becoming more bearish. That raises the question: Whom should we believe?

In our view, that's the wrong question. This isn't about smart money vs. dumb money or dueling surveys. It's about understanding what you're looking at and putting everything in context. No one sentiment survey is inherently right or wrong. Nor is any one survey more or less telling than the others. Surveys are imperfect, particularly when trying to capture a qualitative measure-like an investor's degree of optimism-and provide some precise quantitative measure. They aren't predictive-they tell you more about what just happened than what happens next, because they capture people's feelings at one point in time.

How people report feeling at a given moment is usually based on the very recent past. Gallup held its poll from July 28 through August 6, which means, as the report notes: "The survey was in the field as the Dow Jones industrial average approached, then surpassed, the 22,000-point milestone for the first time." AAII's survey occurred during similarly heady days, as stocks were marching to another set of new highs. That'll make people happy! Meanwhile, Bank of America Merrill Lynch polled its fund managers from September 1-7, as investors were grappling with US presidential administration theatrics, North Korea and the debt ceiling alongside a tiny spate of volatility. The associated feelings for all of these are pretty normal. That's why you don't get very far looking at any one month of any survey. Bear markets don't start because investors were euphoric for a day. Historical perspective and trends are crucial.

One survey approaching 2000-era levels of optimism isn't a sign of euphoria now. If all surveys showed similar euphoria and had for a while, that would be one thing. Perhaps it would mean investors were getting a little ahead of themselves, though it's worth noting the mere existence of euphoria isn't a bull-killer. Investors spent most of 1999 euphoric as can be, and the bull didn't roll over until March 2000. If Greenspan hadn't inverted the yield curve in an overreaction to keeping rates low for Y2K, the party probably could have lasted a few months longer. There is no counterfactual so we can't know. However, stocks are unlikely to move on sentiment alone--the gap between sentiment and reality is what matters most. If expectations are high and fundamentals are grand, that's often a-ok for markets. The trouble comes when euphoria blinds folks to creeping problems and reality can't possibly meet their high hopes.

Surveys are only part of any sentiment barometer, but they are important and perhaps increasingly so this time around. While media are still quite dour, we've previously observed investors starting to tune out the noise and take cues from everyday life, which is how we expect animal spirits to grow and thrive in this bull market. If that holds, media might not be the best reflection of sentiment, and euphoria might not be evident in reporting. That's just the danger of the media being seen as the boy who cried wolf. Eventually, media would likely have to flip to better reflect the popular zeitgeist and target the audience better (remember: media is entertainment). So it's entirely possible that surveys and other indicators will register euphoria that isn't apparent when you turn on the TV or peruse online financial news.

But we are hard pressed to interpret the latest results as anything other than warming optimism-the gradual rise of Keynes' proverbial "animal spirits," a metaphor for the contagious confidence that inspires folks to bid stocks up in a maturing bull market. While Gallup shows folks far more bullish, it's hard to say euphoria is here if more and more managers are hedging against negative volatility. Usually, as bull markets mature and reach euphoria, greed wins out near-universally. That would probably be evident in AAII's survey as well. While not a perfect contrarian indicator, you usually see a much more significant, sustained rise in bullishness there before bull markets roll over. It has been choppy all year, and even this recent high is below levels seen in 2016 and earlier. Even the Gallup survey is off from its late 1990s peak. The level it exceeds today, September 2000's 130, came six months into a bear market, by which time the nascent downturn was starting to make a few folks nervous. That doesn't make the all-time high of 178 a trigger point, but evaluation requires looking at the whole picture, not just cherry-picking comparison points.

As we assess that picture now, optimism is clearly on the rise-no surprise eight and half years into a bull market. Yet this isn't cause for worry. Optimism is normal, and it's where big, late-bull market returns come from. People today misread optimism as euphoria, forgetting both what true euphoria looks like and how long investors can remain optimistic before euphoria sets in. Sunny sentiment can reign for a long while. It stayed for years in the 1990s before euphoria finally took hold in late 1998/early 1999. Some day, this bull will end, but for now, we'd suggest enjoying the ride.