Getting Sentimental

Use investor sentiment to gauge market moves

Over the past year, the market has continued to move in a pronounced seesaw pattern. Concerns about inflation and interest rates have caused investors to rally or abandon sessions, seemingly with the ringing of each bell.

For example, market watchers had predicted that technology stocks-particularly the dotcoms-would short- circuit months ago. However, they posted electrifying returns last year, contributing to the Nasdaq composite index’s amazing rise of 85.6% So how should one measure the performance of specific stocks and sectors in today’s environment? In addition to fundamental and technical analysis, another key tool is sentimental analysis-the often contrarian measurement of investor expectations.

Says Bernie Schaeffer, chairman of Schaeffer’s Investment Research Inc. in Cincinnati, Ohio: “Sentiment analysis offers a third added value for investors. When expectations are high, the market has an atmosphere of vulnerability. When the market has low expectations, there is opportunity.”

He makes his point by examining the performance of Intel (Nasdaq: INTC). Two years ago, market experts, including the financial press, considered the semiconductor giant “overvalued, and [forewarned] that investors should proceed with caution,” Schaeffer says. Conversely, the stock’s price doubled and tech stocks continue to be wired for growth. What tools can you use to assess investor sentiment?

  • Review recommendations of market newsletters. Considered a contrary indicator, analysts use the recommendations of such publications to predict market swings. The market primer Stocks for the Long Run by Jeremy Siegel (McGraw-Hill, $29.95) picks the index of Investor’s Intelligence, a newsletter published in New Rochelle, New York, as a noteworthy yardstick. It found that its ratio of bullish newsletters to bullish-plus-bearish newsletters was “a strong predictor of market return over nine to 12 months.”
  • Evaluate portfolio allocations. Siegel noted another sentiment indicator developed by Richard Bernstein, director of quantitative and equity research at Merrill Lynch in New York. Based on the asset allocations of market analysts and portfolio managers, it revealed that market returns have been high whenever the recommended allocation of stocks falls below 50%-an indication of skepticism about the market’s prospects. Over the past 12 years, one-year market returns have exceeded 20% when such allocation percentages dipped below 50%.
  • Track the flow of funds. Another measurement targets how much money is flowing into certain investment vehicles. For example, the lackluster performance of the third quarter of 1999 could be traced to the meager amounts of money flowing into equity funds-only $32.1 billion, according to the Investment Co. Institute in Washington, D.C. Market performance improved as fourth-quarter inflows exceeded those of the third quarter.

In other words take note of the herd’s reaction. If you have a good stock, however, stick with it.

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