Has sentiment bottomed out?

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Good morning. Chinese officials stated yesterday that they could do without US agricultural and energy imports, should tariffs remain in place — another signal that Beijing is not backing down in the face of US pressure, and that we are entering into a massive game of “trade war chicken”. Who do you think will blink first? Email us: robert.armstrong@ft.com and aiden.reiter@ft.com. 

How bad is investor sentiment? 

The best reason to buy US equities right now is that almost everyone thinks you shouldn’t. When we suggested in yesterday’s letter that there were some — qualified — reasons for optimism about US markets, we received a lot of responses like this one, from a commenter going by “general assembler”:

A weirdly optimistic take . . . The big problem here is that unthinkable things with devastating consequences are increasingly likely to happen. Demolishing the international trade system is one thing, but what about US hyperinflation (if Trump gets his way on low interest rates), US default (the Maga crowd would love the idea of not paying their hard-earned dollars to any pesky foreigners in interest rates), and a ‘classic’ war of conquest?

The oldest rule in investing is to buy when pessimism reigns. So when Financial Times readers are talking seriously about de-globalisation, hyperinflation, default and war all in one sentence, surely it is time to buy? 

It’s not just the FT comments section. The venerable American Association of Individual Investors sentiment survey is as negative as it ever gets. The chart below uses a three-month rolling average of the survey’s bull-bear spread. The AAII goes back 38 years, and it has been as low as it is now only once, during the 1990 recession. The call-outs provide the subsequent one-year return on the S&P 500. When the AAII hits lows like this, it is almost always an excellent time to invest.

Brian Belski of BMO Capital Markets is the Wall Street strategist who is banging the table hardest on terrible sentiment as a buy signal. “The whole thing has become so binary — we’ve all decided we’re going to have a recession,” he says. In conversations with clients in Europe and Canada, the tone is comprehensively negative on the US, he says. “The best [contrarian] indicator of all is sitting in front of clients and looking them in the eye and seeing how negative they are . . . they love the idea of the end of American exceptionalism . . . it’s nothing but emotion driven.”

Belski sees another good contrarian indicator in downward earnings estimate revisions for the next full year (that is, 2026). Analysts revisions are now overwhelmingly negative. Belski argues that when this has happened historically, consensus has overshot to the downside and subsequent returns tend to be above average. His chart: 

Time to load up, then? It’s not quite that simple. 

First, there is the little problem of March 2008, when the AAII hit a deep low after the S&P fell almost 20 per cent. The index went on to lose another 40 per cent over the subsequent 12 months. So sentiment is not a perfect contrary indicator. During a generational catastrophe, it’s no help (that said, the next low in the survey, a year later, nailed the market’s bottom and was one of the best times to buy stocks ever).

Next, it is worth noticing that almost all of the low points in sentiment in the above chart came after the markets had declined very sharply from recent highs. This was true in 1990, 1998, 2002, 2008, 2009 and 2022. With the market off only about 10 per cent from February highs, it is not quite true right now. So maybe investors should wait for an awful sentiment signal confirmed by a bigger market decline?

Related to that, while some retail investors are moaning to survey takers, others (or possibly the very same ones?) are busy buying. According to VandaTrack, retail buyers bought the dips aggressively in the early days of this month, as the purple columns in this chart shows:

Finally, broader measures of sentiment that include not only survey data but also market indicators such as short interest, margin debt and the put/call ratio do not look as terrible as the AAII does. Here is our favourite, Citi’s Levkovich index, which has fallen fast but only to the middle of its historical range: 

We’d certainly feel more comfortable with the buy-on-bad-sentiment argument if it was confirmed by a deeper decline and market-based indicators, and if the impulse to buy the dip had been thoroughly stamped out. We will wait until it is a little darker before we start expecting the dawn.

That said, we are not as concerned about the March 2008 problem — the possibility that we are at the cusp of such a bad disaster that sentiment is no longer a useful indicator. We believe this for a quite specific reason. The market disruptions of recent weeks, in our view, are the product of three things: demandingly high-risk asset valuations, a challenging fiscal/monetary/inflationary backdrop and incoherent economic policy from the Trump administration.

Barring a recession or market rout, the first two are likely to remain in place. On the third, we are reassured — if that is the right word — by the realisation that the Trump economic team simply is not that committed to its own ill-considered policies. So far, when challenged by the markets or the polls, the administration’s response has been to fold its cards. It folded on Chinese electronics tariffs, it folded on “reciprocal” tariffs on the rest of the world, then folded on Donald Trump’s threats to fire Fed chair Jay Powell. All of this in the face of moderate market resistance. It is possible, when it comes to extremely high tariffs on China, Trump will hold the line, however painful the reaction from markets and the economy. But we’re betting he won’t. 

One good read

Specificity.

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