​​​Alger Breaking Views: Investor Sentiment: Proceed with Caution

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In this brief video, Alger Director of Market Strategy Brad Neuman discusses how an appetite for profit-taking can occasionally cloud an investor's judgment.

BRAD NEUMAN: Chances are that when you are really hungry, even bad food tastes good to you. After a big workout or when you have skipped a meal or two because of a busy day, you may not be that picky about what you consume. Many investors begin to feel like that in a bull market – as their appetite for profit increases because of their perceived self-confidence or the fear of missing out, they are less picky in what they invest and often take on more risk. Unfortunately, human nature being what it is, if some investors are feeling this way, the chances are many investors have the same attitude. And so, begins a rapid escalation in sentiment, valuation, and, yes, risk, in our view. 

We believe Investor sentiment is the highest in many years. As this chart shows, the ratio of bearish put buying protection relative to bullish call buying is the lowest since the technology bubble around the turn of the century.

Additionally, margin debt has surged recently, up 34% in the past year as investors speculate more with borrowed funds. This data, along with anecdotes of increased retail investor involvement in the stock market, particularly in small, speculative stocks, supports the notion that the needle of investor sentiment has moved far more toward the greed end of the spectrum than fear.

Strong investor sentiment should make investors cautious, but it doesn’t preclude solid returns. Take the IPOs of the euphoric year of 1999 for example. After underperforming significantly, they have actually outperformed over the past two decades as this chart shows. However, there has been great dispersion with some having filed for bankruptcy, such as eToys, while others have gone on to change how we work and live, such as Nvidia. 
 
The current optimistic environment should be a flashing caution sign for investors and may ultimately produce similar dispersion. Therefore, it calls for more due diligence than before to uncover which companies are caught up in a hype cycle and which are drivers of real change. In our view, this is not a time to get carried away with hot stock tips and message boards, rather it is a time for careful decision-making and intensive research to shine​.







Sources: CBOE; FINRA; Frank Russell Company, Alger Research.

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