Every week, the American Association of Individual Investors (AAII) releases the results of its well-known survey, in which investors are asked about their sentiment towards the equity market.
As we see in the following table, there is currently more pessimism than optimism in the market.
.
Curiously, when this has occurred, returns on the stock market have been more positive than one might expect, as if the majority opinion favored the opposite performance.
In the following chart, we can see some examples of how, when investors were more pessimistic, the stock market rose.
Extrapolation bias tells us that humans tend to extrapolate the most recent data and make it a long-term trend, ignoring previous behaviors.
Something similar happens here: investors, scared by the bad economic news, extrapolate the stock market declines and they see the market with pessimism when, in reality, excessive pessimism is what generates the best investment opportunities.
Similarly, when there is excessive optimism in the market, the stock market tends to drop: the good news do not last forever and, many times, the price already discounts that state of euphoria.
In conclusion, we can say that the Investor Sentiment reflects a attitude in which investors, with their cognitive biases, see the market in a biased way. Perhaps, the advocates of the Behavioral Economics are right.
