The stock market has delivered plenty of chills since the start of the year, but here's one reason why the turbulence should give way to better days ahead: Investors have turned gloomy very fast.
Contrarians love this sort of reaction. Just as optimism tends to coincide with market peaks, widespread pessimism provides a pretty good indication that the market has hit bottom and is ready to rebound.
The overall slide in major market indexes hasn't been too severe, of course, and the past two days of gains have helped temper the damage.
Nonetheless, the volatility interrupts what had been a remarkably smooth ride last year and it comes at a pivotal time: Many observers subscribe to the so-called January effect, where activity in the first month defines what the rest of the year is going to look like.
The Dow Jones industrial average has fallen about 5 per cent in 2014, and five days have delivered harrowing triple-digit declines that hint at an ongoing correction.
Overseas, things are considerably worse. Emerging markets have slumped more than 7 per cent, adding to a difficult 2013, and Japan is down more than 11 per cent.
Investors, some of them sitting on big gains during the market's remarkable run over the past five years, aren't sticking around to see how it turns out.
The latest weekly sentiment survey from the American Association of Individual Investors showed that the level of bullishness has fallen below 28 per cent, down from 55 per cent at the end of 2013, when the S&P 500 finished at a record high.
As well, the Thomson Reuters/University of Michigan consumer confidence survey fell in January in a move that was widely pegged to falling stock prices.
But the sentiment figures that bullish strategists find most encouraging come from moves in and out of exchange-traded funds, or baskets of stocks that trade on exchanges: Investors have been busily selling their equity funds and buying bond funds, marking a hasty retreat toward safety.
The retreat began with emerging market equity funds, following deep concerns that the economies of Brazil, India, Indonesia, South Africa and Turkey (now dubbed the "fragile five") would be hit hard as the U.S. Federal Reserve winds down its bond-buying stimulus program, sucking money out of riskier investments. According to Bank of America, the flow out of emerging market ETFs is now the longest on record.
The money certainly isn't flowing into U.S. stocks. According to Lipper Inc., Thomson Reuters' fund data-crunching company, investors took a net $22.4-billion (U.S.) out of U.S. equity ETFs last week , marking the biggest weekly outflows on record.
During the same period, they moved nearly $11-billion into bond ETFs, marking their biggest weekly inflows on record.
That's a lot of record-breaking. And though it may be tempting to join the stampede out of stocks and into bonds, moving in the opposite direction is often a better way to go.
Investors too often react to old news, from chasing last year's top-performing mutual funds to bailing out of investments that have already soured.
Given the strong reaction to market turbulence already, the worst could be behind us. Michael Hartnett, chief investment strategist at Bank of America, said in a note on Friday that the "big capitulation out of stocks into U.S. Treasuries … marks the end of Jan/Feb correction" – though he added that he doesn't see a "strong buy" signal just yet.
No doubt, the stock market has some issues to deal with, including uneven quarterly earnings reports, a dip in U.S. jobs growth and valuations that suggest stocks are fairly valued at best. But with investors running away from stocks, a little good news could go a long way.
David Berman