Many like to think of sentiment on terms of cycles, and the chart below from the Kirk Report gives a standard view of how these cycles are believed to progress, from euphoria to complete despondency and the back again.
The Kirk Report even took a poll of professionals and found that the majority of respondents said we’re in a stage of the sentiment cycle which supposedly comes after a bottom has already occurred:
63% thought the cycle had already bottomed out while 37% see further downside to go in this cycle.
How did I figure that out? When you look at the overall votes, the most popular response was that we are currently in the hope phase as 26% of those who I polled offered that as their view. This was followed closely by 21% who said we are in the depression phase, followed by 16% who think we are in the optimism phase. If these people are correct, as a combined group 63% of them think we’ve already bottomed out and are headed higher at least in terms of this current sentiment cycle. Please note where each of the three areas of the cycle – hope, depression & optimism – fall within the cycle. After each phase, the market moved higher.
So it’s all upside from here, sentiment-wise?
Things is, when looking at sentiment cycles such as the above, we’ve always wondered why we should be so confident that sentiment moves in such clean waves — ie. with a single peak of ‘Euphoria’ and a single trough of ‘Despondency’?
Couldn’t the path of sentiment potentially look like this, below, with multiple low points of ‘Despondency’ before ever seeing true excitement or euphoria again?
There could be multiple false stages of ‘Hope’ for the market, before yet another visit to the bottom. Maybe we are at a ‘Hope’ stage, but it is just before a sharp reversal all the way back to the ‘Despondency’ of March 2009 when the market bottomed.
Obviously, it’s pretty hard to prove things either way, that’s not our point. The point here is that we shouldn’t get locked into a ‘model’ of sentiment cycles such as the top chart above. In the end, anything can happen and human emotion is notoriously unpredictable and illogical. The sentiment cycle can likely take many squiggly and erratic forms, each time different since each time will be influenced by our knowledge of the past.