I have been involved with the investment publishing industry since 2000. In my first job in the industry, the company I worked for used investor sentiment as one of the main analysis tools in its arsenal. I had been a student of the market for a number of years before joining the firm, but all of my analysis involved technical and fundamental analysis. I didn’t really know anything about sentiment analysis.
Among the sentiment indicators we used were the analysts’ ratings, short interest ratios, put/call ratios, and magazine stories and covers. You have to remember this was 2000, so there was far less information available online at the time, and the owner of the company actually had an intern go through magazines and cut out the paper articles and the covers. They were then scanned to a database for archiving and future reference.
When I started at the company, I wasn’t sure what to think about sentiment analysis, but once I started watching more closely, it really helped explain big moves in stocks. It wasn’t a standalone tool where you just tried to find a stock with extreme bearish sentiment and then went long, you wanted to find a stock with bearish sentiment, in an upward trend, and with good fundamentals. At least if you were looking for a bullish trade idea. Conversely, if you could find a stock that was in a downward trend, poor fundamentals, and extreme bullish sentiment—you had a good bearish trade idea.
For me, it was like adding a third leg to a two-legged stool. When I would see a company beat earnings estimates by a pretty good margin, but then fall afterwards, it was usually easy to see that the sentiment was just too bullish heading into the report.
I have to say that my experience with that firm really helped me develop my strategy and changed how I looked for investment ideas.
When Emotions are High, Big Moves are More Likely
I wanted to share my background with you so I could share something I have learned over the past year. I made a commitment to start contributing to Seeking Alpha in June 2018. One of the first articles I wrote after making that commitment was an earnings preview on Micron Technology (MU).
My overall take on Micron was that the sentiment was too bullish heading into the report. I was bearish for the short term, but bullish for the long term. I thought the stock would drop after the earnings report, but would only fall about 10%-15%, and then the upward trend would resume. I didn’t really expect the stock to drop 50% in the six months following the report, but it did.
What was really interesting about the article were the reader comments that I got. There was one that I asked to be removed because the commenter called me “retarded,” and I find that word offensive. There were others that called me crazy, an idiot, etc. There were a number of comments about how the stock would jump to $80 or even higher, and it was trading just below the $60 level when I published the article.
At first I was a little taken aback by the comments, and I almost responded in a harsh way to some of the comments, but I slept on it and decided to take the high road. I also started watching the comments on some of my other articles and kind of mentally tracking how emotional and abundant the comments were.
First of all, it seemed like I only got the nasty comments when I was bearish on a stock. That made sense to me as people that owned the stock would read the articles and would be upset that I was making a bearish case. I wasn’t attacking them personally, but with some of the comments you would think I had kicked their dog or something. These kinds of comments are signs of how emotional people get about the stocks they own. To me, you don’t want to be emotional about stocks at all. You look at the statistics—fundamental, technical, and sentiment, and then you form an opinion.
A New Sentiment Indicator to Track
Since the article on Micron, I have written another 114 articles on Seeking Alpha. Most of the articles I write are earnings previews. I take a company that is getting ready to announce earnings, and I look at a few of the fundamental stats—earnings growth, sales growth, return on equity, and profit margin are important to me. I also look at the charts for the stock in order to get a feel for the overall trend, potential support and resistance levels, is it overbought or oversold, etc. I then look at the sentiment indicators to see how analysts and investors feel about the stock. I look at things like the overall analysts’ ratings, the short interest ratio, the put/call ratio, and whether those indicators are trending toward a more bullish or more bearish stance.
This process helps me form an opinion on the stock. Something I don’t do is write about stocks that I own because I have already formed an opinion on that stock and when I do an earnings preview, I want to be totally objective.
Over the course of publishing the 114 articles, I have gotten many negative comments from readers, especially on bearish outlooks on beloved stocks. I have learned to shrug off the comments and wait and see whether I am right with my outlook or not, rather than engage in emotional discourse. What I have learned is that the more emotional and abundant the responses are, the more likely my outlook is to right.
Hear me out on this. I am not saying that Seeking Alpha readers aren’t well educated on the stocks they comment on, in fact I find it to be quite the opposite. Some readers know every detail about the companies. I think Seeking Alpha readers are probably some of the best educated readers around. However, when the vast majority are thinking one way and are highly charged and vocal about it, it is a sign of excessive sentiment. It could be excessively bearish, but it is usually excessive bullish sentiment.
When I write a bearish article and then get a great deal of negative comments that gives me greater confidence that my outlook is probably accurate. Again, that has nothing to do with whether those commenting are well educated on the stock or not, it has everything to do with investors being too bullish, period. Emotions are high ahead of the earnings report and expectations are just too much of a hurdle for the company to clear. I have seen it time and time again.
I wrote about International Business Machines (IBM) last fall, and it was a pretty bearish outlook. One reader questioned my reputation and suggested I “go back to teaching,” even though I have never been a teacher. My article was based on the stock floundering, the fundamentals being less than impressive, and the sentiment still being somewhat bullish.
I stated, “If you already own the stock, I don’t see any reason to dump it ahead of the earnings report, but if the earnings disappoint and the stock drops below the $134 support level, I would consider getting out. A break of that support could take the stock all the way down to $110.” The stock would fall below the $134 mark and it dropped to $110 in October and it would eventually drop all the way to $103.50 in December.
I wrote a bearish article on Halliburton (HAL) in January ahead of its earnings report and once again I got a number of negative comments. One reader even asked if I knew what business the company was in. Quite frankly, with most of my analysis, it doesn’t matter what line of business the company is in. I analyze the stock, not the company itself.
For Halliburton I stated, “The long-term trend is to the downside and the fundamentals are below average. The sentiment is skewed to the bullish side and leaves little reason to believe a rally is imminent.
Personally, I will steer clear of Halliburton until the trend changes and the fundamentals improve. It could be a while before that happens.”
Since that article was published, the stock is down approximately 23% and has been down as much as 30.8%. Over the same timeframe, oil is up over 10% and the S&P is up over 13%.
Am I always right? Of course not, no one is ever right all the time when it comes to investing. What I do find is that when I write an article and readers disagree with me in mass and in an emotional manner, I am far more likely to be right.
I think there is a lesson here and possibly a new tool readers can use. If you read an article that is clearly making a bullish case or a bearish case for an investment, if there are a great deal of reader comments that bash the theory—the outlook has a better chance of being right. Again it has nothing to do with Seeking Alpha readers, it is based on herd mentality and too much raw emotion surrounding the investment.
I would venture to guess that when readers comment with a great deal of emotion about a stock, almost all of them own the stock already. If everyone that wants to own the stock already owns it, who is left to buy it and drive the price up? The investors that got in early and are sitting on a profit may start selling and that will drive the price down because there are more sellers than buyers. If you see a bearish article with 50 comments and 45 of the 50 are saying the outlook is wrong, chances are that you have a situation where there are more potential sellers than buyers.
In the most basic breakdown of what makes a stock go up or down, if there are more buyers than sellers, the price will rise. If there are more sellers than buyers, the price will go down. That is the most basic foundation of economic thought. Reading the sentiment on an investment can tell you whether there are likely to be more buyers or more sellers.