The Investment Scientist

Stock market sentiment refers to the overall sentiment of investors towards the stock market. This sentiment can be either positive or negative, indicating whether investors are optimistic or pessimistic about the future direction of the market.

There is a lot of evidence that stock market sentiment is a contrarian indicator of future market returns. Let me cite a few recent examples.

1. When Covid hit the US in March of 2020, the entire market was gripped with fear and there was panic selling. Since then, however, the market has nearly doubled.
2. In February of 2022 when the Ukraine War broke out, European markets also experienced panic selling. It was rumored that billions upon billions of dollars were moved from Europe to invest in the US market. Who would have thought that by the end of 2022, European markets would have higher returns than the US market? 
3. In March of this year, the US experienced two of the largest bank collapses in history.  Some of my clients sent me doomsday articles and asked me if they should pull all their money out of the market just to be safe. Since then, the market has gone up around 20%.

In fact, this phenomenon has been rigorously studied. The chart below details the research results of Harvard Professor of Business Administration Malcolm Baker and NY University Nomura Professor of Finance Jeffrey Wurgler. Here you can see that across all market capitalizations (that is regardless of large stocks or small stocks) the negative sentiment leads to better subsequent one-year returns than the positive sentiment.