Stock Market Groupthink: What It Is and How It Affects Your Investing

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Investing can feel like a solitary process sometimes.

It’s like a long highway drive with lots of hairpin turns. The thing is, investors actually have lots of signposts along the way that can help direct them. Tools like solid financial plans, bootcamps and courses act as a map for our financial lives.

Plenty of Wall Street analysts also claim to know how to get to the promised land of investing success … but do they? And, with so many different voices and opinions, who should investors listen to?

Sometimes—just sometimes, as you’ll see—it pays to go against the grain of mainstream financial advice and do the opposite of what’s being recommended. And right now, in particular, that might mean eschewing popular opinion.

Investors Are Really Pessimistic Right Now

What sounds like a cacophony of opinions from various Wall Street pundits can actually be distilled down to consensus sentiment. This acts as an average measure of bullishness (optimism) or bearishness (pessimism) about the market.

Last week, the Bank of America Merrill Lynch’s Sell Side Consensus Indicator dropped 5.5%. This isn’t a sudden development: This newest reading is the ninth time in 11 months that the indicator has fallen, meaning that analysts are getting more and more pessimistic, likely because of developments in Europe, languishing employment numbers, skepticism about the Fed’s handling of the current financial doldrums and the specter of a potential “fiscal cliff.”

In and of itself, this temperature reading of professional investment strategists isn’t all that important, but the current reading of 49.3 out of 100 is the lowest level going back to 1985. And it’s not just professionals who are sour on the market. Individual investors are also historically bearish on the stock market, as read by the AAII Investor Sentiment Survey.

Given how bad everyone seems to think the market is right now, should investors be heading for the cash hills, avoiding the market completely? Not quite.

Average Sentiment Is Frequently Wrong

It’s well known that we can almost always count on investors to do the wrong thing. When the market is crashing, people are massively selling—bailing out near the market’s bottom. Conversely, when stock bubbles are expanding, investors are right there buying stocks aggressively near the market’s eventual top.

Instead of buying low and selling high after holding for a long time, people tend to do the opposite. Even when we know what we’re supposed to do, we’re just preprogrammed to make poor decisions on the timing of our investing.

So, when you ask a group of people whether the stock market is a good investment or not, you have to take their average answer (their sentiment) with a big grain of salt. Individual investors, professionals, Wall Street strategists—their sentiment is generally a contrarian indicator.

That’s a fancy way of saying that you might want to consider doing just the opposite of their recommendations.

Win Big by Going Contrarian?

In the past, whenever the sell side economic sentiment indicator has been below 50 (and remember, right now it’s 49.3), total returns over the following year have been positive 100% of the time, with the median 12-month return of more than 30%. That’s professional bearishness. When individual sentiment gets extremely bearish, the stock market as measured by the S&P 500 has gained an average of 18% the following year.

And we’ve got both kinds of bearishness on our hands right now. So, in spite of the incessant negative vibes from the media’s echo chamber, investors with an eye on the future may want to consider:

  • Jumping in: If you’ve been thinking about investing (and have been reading The Market!) but haven’t actually started yet, this could be a good time to give it a go. We always say you should invest for the long-term—don’t lock your money away in the market if you’ll need it back within the next five years—so try to ignore the current pessimism and think about how to build your nest egg. If you are looking to get started, we have a checklist to help you set up an investment account.
  • Adding money to existing funds: Maybe you own shares of a fund that’s dropped in value recently, but you’re still hanging on to it because you think it’ll do well in the long term. This may prove an opportune time to buy more of that fund while the price is low.
  • Purchase some new funds: Are you fully diversified? In other words, do you own funds that invest around the world? Do you own funds that invest in different asset classes, like stocks, bonds, commodities and real estate? If not, the contrarian signals say you should be adding to, not selling, your investments now, so this could be a convenient time to rebalance.
  • Value investing as a form of contrarianism: Funds that invest in value stocks—for companies that may be valuable on paper but have fallen out of favor with investors–practice their own form of contrarianism. They often buy investments in industries that have been shunned by Wall Street. For example, Warren Buffett’s investment firm, Berkshire Hathaway, recently tripled its stake in beleaguered Bank of New York Mellon, which is down an awful 48% since August 2007, while its fundamentals indicate it could actually be a good investment. If so, Buffett is nabbing those stocks at a real steal. So, if you believe that this contrarian indicator is right, and that the market will be going up from here on out, then you might invest in a value fund that can find particular stocks that are undervalued now, and will go up in the long run. You can find value funds, and growth or other sorts of funds, by using search filters through your online brokerage tools.

The struggle of being a long-term investor is that most everyone gets swept up in short-term groupthink.

Extreme sentiment indicators are the ultimate signal that, as a group, we’re either too optimistic or overly pessimistic. (In this case, it could be the latter.)

Trying to determine where the stock market wants to go is an extremely humbling process. No Ph.D., MBA or Harvard economics professor really knows what’s going to happen in the future. They’re just taking their best guesses given historical data. But sometimes, taking the opposite tack as these braniacs just may be an investor’s best bet for long-term financial planning.

  • Sandra Marsh

    This is precisely Robert Kiyosaki’s point. It really is beginning to make sense. The stocks going down is quite similar to a sale that happens in a supermarket. One would think that it would induce a similar response in investors as it would in bargain-happy consumers.

  • Sweetnepenthe

    Be consistent and invest steadily. Dollar-cost-averaging. Be the turtle.