One of the more striking features of the stock market is the decreasing pessimism among investors. After the dot-com bust in 2001, we sketched out an algorithm to analyze daily stock market data all the way back to 1928. This innovation records each day’s level of pain and pessimism. Our research shows that high levels of pessimism coincide with market declines and correlate with future good performance and low levels (like we’re experiencing today) eventually mean revert and are precursors to lower than average returns. The correlation isn’t perfect, but it’s good enough to give us some warning signs. And while the markets don’t follow a schedule, it is worth noting that we haven’t had one of the market’s “100 worst days” in over 890 days (which, if evenly distributed, we’d have every 210 days). All this to say that the financial memory is very short; investors have all but forgotten what pain feels like.
The renowned Sir John M. Templeton, known for buying stocks at the point of maximum pessimism, said “Bull markets (long periods of above average returns) are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”