Whether referred to as investor sentiment or investor psychology, how investors are feeling toward a company in a given moment clearly impacts the stock price. Stocks can become overpriced due to heightened optimism and undervalued due to growing pessimism.

Sentiment can become so strong one direction or the other, that stocks can become extremely overvalued or undervalued. The term irrational exuberance was made famous by past Federal Reserve chairman, Alan Greenspan, during a speech he made on December 5, 1996 at the American Enterprise Institute. Irrational Exuberance was later the title of a 2000 book by author Robert Shiller, written to make a case that the stock market was overpriced. Interestingly, the dot-com technology bubble burst at the same time as Shiller’s book release.

There are many people who buy and sell stocks primarily based on stock patterns (technical trends). It is not a practice I’m at ease with personally. However, I know that there are successful stock traders, people who have studied various patterns or trends to the extent they have a great feel for what the patterns suggest could happen next with the stock price. I have several friends who are successful at it. As you know, I’m a numbers guy (fundamental analysis). In my view, stock charts depict investor sentiment and this is what makes them useful to the one who wishes to observe the recent sentiment and speculate on how the market is likely to react toward the stock next.

I see investor sentiment as an important thing to consider, but from a different vantage point than that of a person who is reviewing sentiment (via a stock chart) constantly to figure out what to do next toward a given stock position. Again, I’m not a chart reader or one who trades stocks based on price patterns or trends. However, I do consider sentiment in “big picture” ways. If I’m looking at a stock, for example, that meets my low price and quality standards, and it’s priced at $10, it is of interest to me how it has traded in the, say, past 5 years. If investors have priced it at $40 before and it’s $10 now, with strong fundamentals (solid and significant equity), and the future appears bright, the fact that it has been worth $40 to investors before is something I’ll surely take into account. Had it only traded up to $12 over the past 5 years, my interest is lessened on the possibilities for this investment.

I also consider investor sentiment relative to how I see the overall market indices. Right now, for instance, I’m thinking of Greenspan’s exuberance remark. Why? It’s because, investors remain resilient and bullish even amidst global economic uncertainties of great significance. Stock indices are setting all-time records, signifying a booming economy. Yet oil prices are severely depressed. National debt is beyond nose-bleed levels and escalating exponentially by the minute. Inflation remains tepid. The Fed appears poised to raise rates and yet very reserved about doing so, making sure we all understand that they will do nothing rash and are ever-watching for any hiccups that might alter plans. To me, the Fed is struggling with sizing it all up.

So, as I ponder whether investor sentiment is “balanced” in this broad manner of speaking, I have to at least consider how this should impact my current allocation (weighting) toward stocks. While I’m a numbers guy vs. a chart reader and will only buy after tearing through that balance sheet and ascertaining some important details about the business and its outlook, the concept of investor sentiment, in a broad sense, can’t be disregarded altogether. The difference between optimism and irrational exuberance is one of degree and balance. Of course, the same can be said for pessimism vs. extreme negativity.

Years like 2000 or 2008 show up when investor sentiment and reality collide; when things have gotten out of balance. So, it seems sensible to me to observe investor sentiment, especially from time to time with a wide-angle lens.