≡ Menu

The investor sentiment cycle

There’s a sentiment cycle governing investors’ emotions.

There is something that fluctuates even more than the stock market in investing – and that’s investor sentiment.

Indeed once you’ve been around the investment block a few times, it’s hard to take old-fashioned textbook economics – with their purely rational Vulcan investors and perfect pricing – very seriously.

I’ve observed that just as there’s a business cycle, there’s an investment sentiment cycle. This cycle sees the emotions of investors wax and wane as they lurch from fear to greed and back again.

That’s not to say the old textbooks – or the various forms of the efficient market hypothesis – are entirely wrong.

Later behavioural economists were surely correct that investors often act irrationally and take prices out of whack.

But that doesn’t make it simple to profit from such extremes. The woeful record of most active funds that try to beat the market is proof of that.

A share’s price may well reflect everything that’s publicly known about the asset. This may even include the knowledge that half the people buying it are doing so irrationally.

Yet the price can go even more irrationally higher.

Just think of tech and meme stocks in 2021.

Hunting for highs and lows

So far so straightforward. Avoid getting swept up in a mania, invest with your head not your heart, and sidestep the dangers oscillating investor sentiment, right?

If only it were that simple.

For starters it’s only in retrospect that you can clearly read back a cycle of fear and greed – even when you understand that bull and bear markets are at least partly emotional, and you’re alert to all the signs.

You’ll often see exuberance and reckless trading years before a given market tops out. Get out too soon and you’ll miss years of gains while you wait for a crash that might never come. (Miss enough gains and it might not have been worth abstaining overall, even if and when the market does crash.)

Betting against the market is always risky, both financially and emotionally. The great economist John Maynard Keynes said “the market can remain irrational long after you can remain solvent”. But what Keynes didn’t mention was that even if you avoid betting against a crazy market, you can still feel pretty lousy in your haughty solvency for as long as everyone else is making out like bandits.

I’ve been there many times.

For instance, in the previous version of this article published in 2010 I wrote:

I’ve avoided gold miners for years, despite their popularity, because gold has long seemed detached from reality. More fool me.

The gold price looked very stretched back then. Yet powerful undercurrents of fear that followed in the wake of the financial crisis kept its price bobbing along.

My patience was even more stretched. Sitting out this market while investor bulletin boards were full of my stock-picking peers doubling or tripling their money in a year was not easy.

It wasn’t until 2013 that my avoiding gold miners was at all rewarded, as the boom ended in a bust.

Who knows what money I failed to make before then?

The real zombie investments

I’ve been through similar cycles with everything from oil companies to tech shares to bonds to Bitcoin.

This is one reason I never say never again about any asset class or investment opportunity. I’ve seen too many supposedly surefire investments flounder. Even as others rise from the dead again when, eventually, both their fundamentals and investor appetite recovers.

If you leave entire sectors or asset classes behind every time you get your fingers burnt, you’ll soon end up with nothing left to invest in. Because they will all burn you from time to time.

Better to learn your lesson and leave only your emotions behind if you can.

Peak bullshit

One of the best things about updating very old Monevator articles is that since-proven illustrations are often just sitting there on the page.

Again from the previous version of this post from 2010, I wrote:

It seems like every private investor I meet nowadays owns a portfolio of oil companies, variously prospecting in the Mongolian steppes or trying to snake a pipe under the Arctic.

These people (maybe you’re one?) will tell you earnestly that oil shares are the only game in town, and peak oil makes all other investments irrelevant.

Indeed as far as I can tell, every 50-year old man who dabbles in shares (and they’re always men and over 50 these days, which says something in itself) thinks humanity’s future is to transport bundles of copper and gold back and forth between China and India in gas-guzzling trucks at great profit to themselves, while the rest of the world burns its old Tesco share certificates and 50 pound notes for warmth.

No place for media companies. No point in buying shares in breweries or builders. No future for whoever makes those fancy leggings that all the girls in London are wearing.

These peak oil investors have endless technical arguments as to why they’re not the last punters to turn up before midnight. They are supremely confident, and they grow more confident by the day.

We’ll see, but history is not on their side – all one-way bets hit the wall eventually.

Well this mania did indeed prove a tell.

Most oil and gas producers – and other commodity producers – started a decade-long slide down soon after.

You may recall the oil price briefly went negative in March 2020? By then, the iShares basket of oil and gas producers (Ticker: SPOG) was down 75%:

And as the graph shows, prices going negative – and every oil bull checking into the slaughterhouse – turned out to be a historically good time to buy.

(Do I sound smug? I shouldn’t – because buy I did not!)

Dot come again

If you think that’s an impressive bit of Mystic Meg action, you’re going to love what I wrote about tech stocks in the 2010 edition:

For a contrasting unloved sector, consider technology companies.

It’s hard to remember a time when half the office owned shares in nonsense companies like Baltimore, Webvan, and NTX. Yet it was only a brief decade ago that the Dotcom stocks were doubling in a month on a good press release and a name change.

Today roughly nobody except institutional investors bothers with individual technology shares – yet the Nasdaq tech market in the US has been quietly beating the Dow and the S&P 500 for months.

Blimey! This is how someone gets themselves a big head. (Or a permanent place on rotation on CNBC.)

I went on to speculate that the seeds were being planted for a new boom in technology shares:

  • The first shoots will be obscure magazine articles on the Nasdaq’s recovery.
  • Then you’ll discover a friend or a bulletin board poster who has tripled his money betting on cloud computing micro-caps.
  • Perhaps Facebook or Twitter will float for what will seem a crazy valuation, but will look positively modest a few years later.
  • Some new kind of fusion or computer or website will emerge and capture everyone’s attention.
  • Whereas today there’s less than half a dozen surviving UK funds focused on technology, by then there’ll be dozens. You can’t miss them – they’ll be advertised in all the Sunday papers.
  • The last lemon will ripen in 2020, when even you and I will buy shares in a Korean software company that’s a rumor we heard from an old boss who’s confused it with gadget in a movie he saw on the first commercial space flight to the moon.

And then the bubble will burst. We’ll all wonder again what we were thinking, and put our savings into ‘risk-free’ Chinese government bonds and middle-class apartment blocks in New Dehli.

Okay, so I lost the plot a bit at the end there – the dangers of long-range speculation.

But I think these examples – which you’re welcome to check back on using the Internet Wayback Machine – show that it’s possible to judge what’s in and out of fashion at the extremes.

Again though, don’t confuse ‘possible’ with ‘easy’.

A cycle for all seasons

To conclude this walk down memory lane, last time I finished by reminding readers how I’d suggested in 2009 that we might be on the cusp of a new bull market:

I don’t know how the next bull market will play out. Maybe it’s not the turn of technology shares again quite yet. Maybe investors will go mad for Chinese small caps or German widget makers instead.

Oh well, I was half right!

But the important point is not that you can predict what’s coming next. It’s not even that you can be sure that cycles are reaching a peak or about to burst.

Not gonna lie, after a rotten couple of years in the market revisiting this article has boosted my ego.

But still, in practice commodity shares did continue to run for at least another 18 months after I flagged the oil and gas mania. As for the new tech boom, I certainly benefited – it did most of the late-stage heavy-lifting that took me to FIRE – but by no means was my portfolio as full of them as it might have been.

More recently I’ve been cacking things up anyway, getting back into growth stocks too soon after the 2021 sell-off and ditching UK investment trusts I’d bought to ride out the turbulence before they rallied.

Active investing is hard and best left to masochists who are wired a certain way. We’ve argued that many times.

So what is the important point?

Just that thinking about the sentiment cycle can be helpful.

Investor sentiment 101

Try to step outside of the current tumult from time to time to consider the broader currents – whatever kind of investor you are.

  • You should understand your own emotions – why we all feel fearful, brave, or even guilty at different times.
  • If you’re an active investor, you can potentially profit by guessing how others are feeling, and placing your bets accordingly. Never bet the farm! Stay humble.
  • If you’re a passive investor, the cycle explains why you should keep on investing through the market’s ups and downs. You’re not being reckless by seeing the cycles play out and yet perhaps doing nothing different. By staying on course you’re strategically taking advantage of the oscillating and unprofitable emotions of your fellow investors.
  • You might also keep an eye on technicals like CNN’s Fear & Greed index.

Always remember: this too shall pass.

Not everything changes

Think this is all too obvious?

Okay, but – for example – have you been loading up on super-safe government bonds despite their recent rotten run?

Have you been salivating as real yields on index-linked gilts turned positive?

Or have you been one of those writing in the Monevator comments to say that you don’t see the point of bonds anymore and you will never invest in them again?

Sure there are valid reasons why you might reply “not for me” or at least “not yet”.

But that bond prices have gone down a lot and everybody hates them is as bad a reason to avoid them as exists if you’re any sort of long-term, diversified investor.

It will not always be this way.

The crying game

When I first wrote about investor sentiment and emotions back in 2010, the idea that investors’ emotions constantly shifted with narrative and price remained controversial.

Yet only a few years later Robert Shiller won the Nobel Prize in Economics alongside Eugene Fama – efficient market royalty – and Lars Hansen (who we’ll get to another day.)

For Shiller to take the 2013 award along with Fama was proof that behavioural economics – and ideas like investor sentiment – are now part of the framework of modern market theory.

So much so, in fact, that younger readers might now take it for granted.

Fair enough. But let’s see if that stops investors getting carried away again in the future.

Personally I will be betting against it.

{ 21 comments… add one }
  • 1 you be the bank December 10, 2010, 5:24 pm

    all i can say is that it scares me to see words like “guessing” and “placing your bets” I don’t know why anyone in their right mind would at this time put any of the money they need for retirement at risk. Does america understand that when you contribute to a government sponsored plan you are not saving you are investing, which means you could lose all that money. we need to learn how to SAVE for retirement not ‘place our bets’ on our portfolios and invest for retirement.

  • 2 Nanette Byrnes December 10, 2010, 6:16 pm

    Interesting piece. Looking at sentiment through the prism of what sectors or investment stories are hot is probably a better route than the sentiment indexes that try to reflect our feelings toward the market overall. The American Association of Individual Investors’ sentiment gage has been zig zagging all over the place this year. It’s thought of as a reliable counter-indicator of where the markets headed, and those tea leaves were getting pretty hard to read. Then I read a piece in the Wall Street Journal about how small the sample size is — 200 to 300 self-selected investors, many retired, probably the same core bunch every week. In polite terms “not statistically valid.”

  • 3 ermine December 10, 2010, 10:03 pm

    Well, I fit most of the criteria of the peak oilers, with the exception that I haven’t got any oil shares (other than presumably in a index ETF and in an IT).

    The trouble with peak oil, is that if it comes to pass, is that it will sock it so very hard to the fundamental assumptions of capitalism that you’d need the talent of Buffett or Soros to make any money out of it, whatever money may mean by then.

    There are some things you can’t fight with investments. Peak oil is one of them. A litre of petrol is about 10KWh of stored energy, that’s about equivalent to the human output of two weeks of hard physical labour for 8 hours a day. It’s a snip at £1.20 That’s why to be rich in the pre-oil age you needed to have servants or slaves. People may be able to get away with just servants post PO if we play our cards well 😉

    I agree, if there are guys that reckon their oil shares will hedge peak oil they’re away with the fairies.

  • 4 OldPro December 11, 2010, 10:45 am

    “Animal Spirits” Keynes called the hunger for risk… I sense the spirits are rising even in my splendid isolation, of today… well, relatively splendid: don’t tell the wife.

    To “ermine”, I would say I have heard many theories in my long life… Does anyone remember any more that the world was going to freeze? Yes, that’s what they told us in the 1970s… I am not a global warming denier, but I do deny inevitable catastrophe. We see the threat, not the blind side that’ll hit us… personally it’s a fatal flu epidemic I fear.

  • 5 ermine December 11, 2010, 9:01 pm

    > any more that the world was going to freeze?

    Yeah, I remember hearing that at school 🙂 Climate change, however, isn’t the same as peak oil, and there are a lot more potential consumers coming on line than the 500-750 million or so of the original Western World from the 1950s to the 2010s. It’s not been getting easier to find oil since the 1960s and the demand could increase by 5-10 times if we all want to live an American lifestyle. However, I do acknowledge that human ingenuity hasn’t run into a brick wall so far!

  • 6 Mark Carter February 12, 2011, 10:21 pm

    My own theory is that even if you accept Peak Oil and oil prices going up ever-higher in future, that still doesn’t mean it’s beneficial for the oil companies. Prices may go up, but volumes will go down. My argument is marginal costs will go up as oil producers find it increasingly difficult to obtain oil. It’s a scenario in which nobody wins.

  • 7 Jonathan B August 24, 2023, 9:55 pm

    @OldPro, “Does anyone remember any more that the world was going to freeze?”

    I assume you are thinking of the predictions of “nuclear winter” following a nuclear war. It would be interesting to know if that is still thought to be the scenario, but not to the extent that one would recommend letting off nuclear bombs round the planet to counter global warming.

    And back to the topic: the example of bonds is pertinent, if it weren’t for sentiment people would be buying up gilts since they must be near the bottom and due to rise. But human emotions means that isn’t likely to happen until they are clearly seen to be rising again,

  • 8 Pikolo August 25, 2023, 8:34 am

    Thank you for introducing me to the Fear and Greed index, seems interesting

  • 9 Neverland August 25, 2023, 10:23 am

    It’s hubristic to claim that in 2010 investor sentiment and emotions weren’t widely written about

    Benjamin Graham wrote The Intelligent Investor in 1949 which was premised on the irrationality and group think of an imaginary mr market

  • 10 The Investor August 25, 2023, 10:29 am

    @Neverland — I didn’t say emotions and sentiment weren’t widely written about. But hey, that’s never stopped you before.

    I said the EMH still mostly ruled the roost — especially in academic/wonky circles. Buffett and Graham (who unlike you I’ve actually read) were still (and are still in some quarters) perceived as just lucky coin tossers.

    People have of course been talking about sentiment for hundreds of years. But there’s a spectrum. (Today I’d say it’s if anything over-weighted).

  • 11 Kerry Balenthiran August 25, 2023, 12:34 pm

    The sentiment cycle, or psychological cycle, is the key thing that underpins bull and bear market cycles. It is human nature to get overexcited after a prolonged period of price rises and to suffer excessive pessimism at the lows.

    Understanding market cycles is crucial to firstly avoiding these mistakes yourself, and if you are able to, profiting from them.

    What I love about market cycles is that it forces you to stop and think about the fact that trends don’t last forever, either up or down, and what is going to cause the trend to change, and when might it happen.

    I’ve written an article about the 17.6 year stock market cycle here:



  • 12 The Investor August 25, 2023, 2:15 pm

    @Neverland — It’s 2023 and I first got on the Internet in 1991. Why do you bother with this old-school shape-shifting argument-changing trolling behaviour? Have you never sought counselling?

    You’re back on my auto-delete list.

  • Maven
    13 BBBobbins August 25, 2023, 2:23 pm

    Surely there is a form of sentiment which is not engaging in the manner of actively choosing to be passive in relation to timing decisions or perhaps more substantially just having inertia re one’s investments. In the latter category I’d put the many people with DC pensions or SIPPS who set them up and let them run on autopilot.

  • Mogul
    14 PC August 25, 2023, 4:20 pm

    A couple of books spring to mind
    – The Madness and Popular Delusions of Crowds
    – Reminiscences of a Stock Operator

  • 15 Algernond August 25, 2023, 5:06 pm

    Read a couple of books on cycles recently. One of them was Akhil Patel’s The Secret Wealth Advantage.
    He talks about the ~ 18-year property cycle being the underlying driver of all other cycles (including market sentiment).
    Interestingly the 18-year cycle seems to have been skipped during World War II. So that begs the question, when we look back in a few years’ time, will the Covid-War also have had a similar level of cycle disruption ? And if we then have further lockdowns, ostensibly due to viruses or climate, how will that affect the market cycle? Then again, perhaps we really are in a Fourth Turning (sentiment driven cycle), and it’s all to be expected.

    The other cycle book I read was the Howard Marks one. I found it interesting, but rather light on data.

  • 16 The Investor August 25, 2023, 5:35 pm

    @Algernond — You might like Ray Dalio’s magnum opus on the credit cycle if you’ve never ploughed through it before. (Beware, set aside a weekend and a lot of tea/wine!)


  • Mogul
    17 Time like infinity August 26, 2023, 12:13 am

    @TI – thanks for updating this superb piece. It’s spooky to read the comments from December 2010. Since subscribing, I’ve been going back and rereading (and in some instances re-rereading) earlier Monevator articles and comment threads. It’s striking to me how what I can recollect now of my reactions to events back then chimes with the mood music of those times.

    But the contemporary zeitgeist was not necessarily a useful or actionable steer.

    So whilst @ermine regrets taking on risk and home buying in 1989, inbetween the abolition of MIRAS pooling and lending rates hitting 14.88%, my own regret is the opposite. Bailing out of risk because of the palpable fear in the air from the onset of the GFC in 2008 through to the Greek and Cypriot debt and banking crises several years later (thank God overcame overcast sentiments to finally, in 2013, reinvest in the global equity market).

    During that period much of the financial blogosphere was alive with an electric pessimism. It was sincere and persuasive, but mostly wrong. There was no Great Depression 2.0. Hyperinflation did not cause gold to go to five figures. We did not face an imminent energy crisis. ‘Absolute Return’ strategies did not trump simple buy and hold. This was not ‘the big one’ which Robert Prechter and the Elliott Wave crowd have perpetually prophesied.

    We may each like to imagine ourselves to be calm and detached observers of the sentiment cycle; but in reality we help to create that cycle and, in the moment, we are just as much a part of it as are others.

    Sentiment reaches its extremes mostly in retrospect. At the time it typically seems somewhat rationalisable.
    – Dot Com boom: most commentators were calling for bust in 1998 and 1999, during which time the returns were strongest.
    – End of 1999: almost every bear had capitulated. New metrics had emerged to explain why what had been said to be in a bubble at half the price now was actually cheap.
    – 2009/10: almost every voice insisted that the worst still lay ahead.
    – Early 2008: near universal view things looking up after 2007’s credit crunch.
    – In 2002/3 the Tech Media Telecoms/new economy stocks were written off. One felt a bit foolish then to even be looking at such discredited names.
    – Late 2021: those same names now could seemingly do no wrong.
    Thus it was, and will be evermore. As the saying goes, the stock market only exists to make the largest number of people look as foolish as possible as often as possible. Best to assume that no one actually knows anything reliably about the future direction of asset prices, including oneself. Think probabilistically. Recognise information can sometimes be unclear, unreliable and uncertain, and that it is almost always incomplete. Things may occasionally be binary in outcome, but generally they aren’t. What worked in the past might not in the future. However, where there’s robust, detailed and diverse evidence of persistence in performance in the past, then it might be sensible to give some weight to that when constructing portfolios.

    @Kerry Balenthiran #11: got interested in your ideas after Barry Ritholtz’s review of the 17.6 year cycle way back in November 2013. It’s an elegantly put idea, and I’m grateful for your work on it and for your sharing it.

    What I understand you to be saying is that awareness of the possibility of cyclicality can be useful; and not that there is an actual iron rule in favour of waves of a certain periodicity or amplitude, e.g. it is one possible rule of thumb (or at least a past pattern) to be cognisant of, rather than a rule of nature.

    Do you see major externalities like COVID resetting any pattern here? i.e. the 17/18 year period that may, in the theory, have begun in or around 2017 now instead restarting from 2022?

  • 18 Ben August 26, 2023, 8:55 am

    “If you’re an active investor, you can potentially profit by guessing how others are feeling, and placing your bets accordingly.”

    I agree with this behavioural strategy but I suspect you only get significant alpha at times of maximum negative sentiment. My rule of thumb is to invest when a stockmarket panic is so bad it makes it into the headlines of TV news. The news reinforces the panic. For a brief period, everyone is selling irrationally due to loss aversion and the market is undervalued. That’s the moment to put a large sum into an index tracker to buy the market as a whole, before the panic evaporates and the media moves on to the next short-lived headline. This is the only active investment play I ever attempt and it’s worked well so far, some highlights being the Fukushima nuclear accident and peak covid.

  • Maven
    19 miner2049er August 26, 2023, 10:23 am

    What hits home to me as a late passive monevator investor (8 years (previous to that I was playing cash ISAs in icesave)) is, the information about cycles exists previously and currently but for me it’s not until it’s experienced it hits home and for me coming up to age 50 I might only have a couple of them left. I will use this opportunity to try to excite the mini miners (21,19) to give them a head start, that no doubt I’ll be ignored by them until the next cycle in there 30’s at least they get a generation jump on me 🙂

  • 20 petejh August 26, 2023, 1:58 pm

    What we don’t want is a critical mass of investors becoming aware enough of their own emotions that they no longer succumbed to poor investing choices due to fear or greed… the market would have to change so as to punish or reward a different set of behaviours. But, there’s one born every minute.

  • 21 bob thebleeper August 27, 2023, 10:19 am

    I just came across this site & will definitely return. Just a word of caution: the examples of previous successful predictions remind me of the Parable of the Baltimore Stockbroker, recounted by Jordan Ellenberg in his book “how not to be wrong” & summarised here: https://medium.com/thebalancedinvestor/the-parable-of-the-baltimore-stockbroker-97f616acaecb

    TLDR; hindsight is 20/20!

Leave a Comment