Bearish Newsletter Sentiment as a Contrarian Indicator

This could be an outstanding buying opportunity

Senior Quantitative Analyst
Mar 30, 2022 at 8:00 AM
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Editors at Investors Intelligence collect over 100 stock market newsletters and designate them bullish, bearish, or calling for a correction (short-term bearish, but longer term bullish). A few weeks ago, the number of bearish newsletters topped the number of bullish ones for the first time since April 2020 -- a time when the world was dealing with the Covid-19 crisis.

Current anxieties include the war between Ukraine and Russia and inflation. I’m looking back historically to see if newsletters have been good at forecasting the market or if they make for a reliable contrarian indicator.

A Contrarian Indicator

First, I’m taking a general look at how the Investors Intelligence sentiment survey has performed as an indicator. Using the value of the percentage of bullish newsletters minus the percentage of bearish newsletters, I separated the weekly results into deciles. The table below, with data going back to 1972, shows the average return of the S&P 500 Index (SPX) over different time frames for each decile. Green cells are those that beat the overall average for that time frame, while pink cells underperformed the overall average.

The top of the table corresponds to low readings, which means the newsletters are relatively bearish compared to rows farther down the table. I bolded the second and third rows, because the last few readings have landed in those ranges. This looks like a reliable contrarian indicator. The short-term returns are random, but when you get to four- and eight-week returns, the outperforming deciles are the four rows at the top of the table. Where we sit now (in the second and third decile), the S&P 500 has averaged a return between 2.3% and 3.0% compared to a typical eight-week return of 1.3%.


When Newsletters First Become Bearish

The table below summarizes the performance of the SPX after the Investors Intelligence bulls minus bears turns negative. I’m only including instances where it was positive for the three months preceding. The data shows these are outstanding buying opportunities both in the relatively short-term and longer-term. Two weeks after a signal, the returns simply match typical market return shown in the second table below. After that, however, the outperformance is stark. Eight weeks after a signal, the S&P 500 gained an average of 4.7% with 78% of the returns positive. Typically, the index gains an average of 1.3% over that time frame, with 63% of the returns positive. Six months after the newsletters first turn bearish, the SPX gained over 12% on average with, 89% of the returns positive. That is impressive, and hopefully this trend continues.



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