I never have been much of a believer in all the hype about using sentiment polls as an indicator of the stock market. When looking at the past performance of many of the stock or consumer indexes leads to confusion to many of the average laypersons use of these indicators. We will look at one that we think may help in the confusion and actually may be helpful when used with other stock market indicators. Looking at the University of Michigan Consumer Sentiment Index one can see a drop in sentiment before a large stock market drop occurs.(>15-20%). What one can't determine from this chart is when an investor should become concerned.
The next chart helps to clear up some of this confusion. Using 2 moving averages and the crossing of these different time trends, points to a decent indication of larger drops that may occur in the stock market. While no one indicator should be used alone, if used with other indicators of your choice we think this chart may be of some use. Please not there was one false or early signal using this method.
Conclusion
While not perfect as most stand-alone indicators, we think this sentiment index when used with your other stock market tools may help give you a possible heads up in larger type downturns that longer term investors may want to avoid. We think risk management is important to your portfolio growth and a much underestimated tool. Investors are led to believe they are better off to stay in the market at all times. We are of the opinion no matter what your diversification is, that one can show excellent returns by NOT being fully invested at all times, and also having a much lower risk/return ratio. Money management is about Risk Control, Principal Protection and Profit Taking. We want to minimize the downside risk (psychological and financial) of bear-market declines.
