There’s a common market adage that says, “sentiment follows price,” but this year has been an exception to the rule. What can we take away from this year's sentiment and the recent lack of bears?
There’s a common market adage that says, “sentiment follows price.” This year appears to be an exception to the rule, as sentiment has remained abnormally subdued despite another solid performance from stocks. The S&P 500 has risen 15% for the third consecutive year, and the index has now reached that level six times in the last seven years. Combating market returns has been the abundance of negative headlines this year, with tariffs, valuations, and a potential bubble weighing on investor confidence.
The American Association of Individual Investors (AAII) surveys its members weekly on the direction they believe the stock market is headed over the next six months, with responses ranging between up (bullish), no change (neutral), or down (bearish). The average percentage of respondents with a bearish stance on the market has been 44% this year, which is the highest of any year outside of 2022 and 2008. That said, the market showed signs of renewed optimism in the most recent survey released on Thursday. Over the last week, just 30.8% of respondents thought the stock market would be lower in six months (AAIIBEARS), down from 42.7% in the week prior. That marks the lowest level since January, a stark contrast to sentiment throughout most of this year
Another gauge of investor confidence is the Bull-Bear Spread (AAIISPREAD), calculated by subtracting the percentage of bearish respondents from the percentage that are bullish. A positive reading indicates more bulls than bears, while a negative reading suggests the opposite. Similar to AAIIBears, the sentiment spread has been abnormally low this year.
Readings above 30 for the spread can signal market euphoria, while levels above 15 indicate above-average bullishness. The last time the sentiment spread was above 15 was in December of last year, which marks the fourth-longest streak without hitting that level. Today’s AAII survey saw the bull-bear spread reach 13.5, meaning the streak could come to an end shortly, but that wouldn’t be a cause for concern. Streaks lasting 40 weeks or longer came to an end in June 2023, November 2020, November 2016, and Jun 2009, all of which preceded above-average returns over the next year.
In addition to the streak, the magnitude of sentiment has been abnormally low, as the bull-bear spread has an average reading of -10.5 this year. That is the fourth-worst period on record, with only 2022, 2008, and 1991 seeing lower sentiment across the full year. Given the pessimistic expectations shown, should investors be worried about a slowdown in 2026?
Typically, investors haven't been great at predicting the future performance of the market. Higher levels of bearishness have actually been associated with better returns, as we’ve explored in previous articles. Thankfully, this same phenomenon extends to sentiment across the full year. There have been six instances since 1988 in which the AAII sentiment spread has been negative on average across a calendar year. Of those six occasions, the S&P 500 has not only been positive in each of the following years but also done so by at least double digits. The average return following those six years is a robust 22.2%, with the minimum coming in at 12.8%. While sentiment can only offer so much context, the pessimism this year does lend credence to the notion that the market’s run of gains is in its seventh-inning stretch rather than the ninth inning, especially with domestic equities still displaying significant relative strength.
