As a follow up to last week’s look at the AAII Investor Sentiment survey this week we take a look at the NAAIM (National Association of Active Investment Managers) Survey of Manager Sentiment. Last week we confirmed the consensus opinion of the AAII survery as a contrary indicator. On average, when individual investors are most bullish the average 1-year return to the S&P 500 is 1.9% compared to 13.6% when investors are most bearish. The question is; are professional money managers any better than individuals at predicting subsequent returns? Is the “smart money” truely smart?
According to the NAAIM, the survey polls:
“member firms who are active money managers are asked each week to provide a number which represents their overall equity exposure at the market close on a specific day of the week, currently Wednesdays. Responses can vary widely as indicated below.”
Range of Responses:
-200% Leveraged Short
-100% Fully Short
0% Cash or Hedged to Market Neutral
100% Fully Invested
200% Leveraged Long
The survey has been conducted weekly since July of 2006. The current weekly average response is 68.3%, with an average reading over the 4+ year history of 49% and a standard deviation of 24%. For the purposes of this analysis, extremely bullish periods will be considered those at or above 75% and bearish periods are at or below 25%, or roughly one standard deviation from average.
This analysis will be divided into four sections. The first section will look at the entire data series, which started in 2006. The second will look at instances of “extreme” bullishness where bullish sentiment was 75% or higher. The third section will look at instance of “extreme” bearish sentiment where bullish sentiment was 25% or lower. Finally, the last section will look at periods where both the AAII and NAAIM are either extremely bullish or bearish.
The entire data series since 2006 has 221 periods and again I have elected to look at the returns over the following thirty, sixty and 360 days from the date of the survey along with returns leading up to the survey of thirty and 360 days. Summary statistics can be found in the following table.
Similar to what we found by looking at the AAII survey, notice the negative correlation between the survey and subsequent S&P 500 returns and the positive correlation to prior returns. Bullish sentiment and S&P 500 returns tend to move in opposite directions; higher sentiment, lower returns and vice versa.
Next we look at period of “extreme” bullishness, identified as periods above 75%. There are 37 such observations in since the survey started.
Notice the average subsequent returns when managers are most bullish; over the 30, 60 or 360 periods all average subsequent returns are negative. Contrast this with average returns of 2.7% and 18% over the prior 30 and 360 days respectively. Similar to what we found by looking at the AAII survey, the data seems to suggest that “extreme” bullish sentiment is influence by the prior period’s return. Notice that the highest correlations are on prior returns and not subsequent returns.
In terms of “extreme” bearishness, where sentiment is below 25%, we have 43 periods to analyze.
Similar to what we find when looking at “extreme” bullish sentiment the highest correlation is with prior return. The average 360 day subsequent return during bearish periods is 11.6% which is much higher than the -4.9% we find during bullish periods.
Finally, combining the two sentiment surveys we will look at periods where both survey have a bearish reading (there are only 4 observations of both surveys with an extremely bullish reading, too few to analyze). When looking only at periods where the AAII survey was below 28% and the NAAIM survey was below 25% we have 16 observations.
When both surveys are signaling extreme bearish sentiment the correlations seem to be higher than when only one survey is used. Furthermore, average subsequent and prior returns are more extreme than when only the NAAIM survey is bearish (a note of caution here as there is a small sample size for this subset).
In summary, even when looking at a survey of professional investor sentiment, a contrarian approach does appear to be advantageous during period of either “extreme” bullish or bearish sentiment. Average 360 day returns during periods of extreme bearish (bullish) sentiment are 11.6% (-4.9%) versus the complete period average of -3.2%. This indicator along with the AAII survey would best be used as a contrary indicator and in conjunction with other data and not as a trading tool in and of itself. However, in periods of “extreme” bearish sentiment investment conditions appear more favorable. In this case, it does not pay to “follow the smart money.”