What are the odds?

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  By Guest Blogger Doug Rowat

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Each week, the American Association of Individual Investors (AAII) asks its members a simple question: Do you feel that the direction of the stock market over the next six months will be up, flat or down?

In recent weeks, the AAII Sentiment Survey has turned sharply bearish, currently sitting at 61% bearish, 20% neutral and only 19% bullish. A 61% bearish reading is meaningful because savvy investors look for these extreme readings (more on this later); but regardless, sizeable fluctuations in the Survey results over the past few weeks perfectly illustrate how easily investors succumb to recency bias.

In less than a month, we’ve seen the AAII Sentiment Survey bearish reading hit a low of 34% and now this recent high of 61%—a 27 percentage-point swing! Has anything happened in the world over such a short timeframe to shift outlook probabilities so dramatically? Trump’s tariff threats certainly aren’t new. Further, when he delayed their implementation, the bearish reading then plunged 7 percentage points. But why? He could just as easily implement them next week when the grace period ends.

But this is how recency bias works. Recent information significantly distorts our perception of future probabilities. The media, of course, feeds this. As Scott Nations highlights in his book The Anxious Investor:

The problem is not that investors overreact to a carefully curated analysis of all data. The problem is that they overreact to the most recent, most attention-grabbing data.

So, in our present circumstance, dramatic tariff news headlines distort our sense of how likely they are to be implemented and how long they might last. It’s not that Trump won’t implement tariffs next week—that remains a definite possibility—it’s that the shifts in sentiment (bullish, bearish and neutral) aren’t rational. Trump is, to say the least, mercurial, and the recent headlines provide little insight into his true long-term intentions. Even if Trump goes forward with tariffs next week, for example, their ultimate duration will remain a mystery.

But irrational assumptions regarding future odds are the hallmark of recency bias.

To illustrate, the airplane and helicopter mid-air collision in Washington last month has, illogically, shifted Americans’ perception of air transportation danger. According to a recent Associated Press-NORC Center for Public Affairs Research survey, almost 20% of US adults now believe that air transportation is “very or somewhat unsafe”, up from only 12% in 2024. But this substantial percentage increase makes no sense in light of the fact that the National Safety Council says that airplane-related fatalities are so rare that the odds of them occurring can’t even be meaningfully calculated.

The new 20% “very or somewhat unsafe” survey result is also extraordinarily high given that, on a global basis, airplane fatalities, which have always been extremely unlikely, have actually decreased 97% since the 1960s:

Fatal plane crashes per million flights, by decade

Source: IATA

This brings me back to the AAII Sentiment Survey. As noted, it dovetails with recency bias. So, if recency bias distorts probabilities, then extreme AAII Sentiment Survey readings become useful contrary indicators.

Highly elevated bearish readings north of 50%, for example, were recorded near the lows of the Covid bear market in 2020. The Survey also produced a more than 60% bearish reading near the bottom of the inflation-induced 2022 bear market. In March 2009, the AAII Sentiment Survey recorded an all-time-high bearish reading of more than 70%, which, of course, marked the precise bottom of the financial crisis.

The average long-term AAII Sentiment Survey bearish reading is 31%. A 61% bearish reading, therefore, is extreme, and when the reading becomes extreme, it becomes useful. Such bearishness possibly signals that investors are misunderstanding the actual risk represented by Trump’s tariffs, or at least misunderstanding market risks in general. It may therefore mark an opportunity to add to portfolios or take on more risk.

Trump never makes it easy, of course, but at some point ignoring the flurry of troubling recent news and remaining bullish, might end up being the most profitable stance that investors take in 2025.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Investment Advisor, Private Client Group, Raymond James Ltd.