Certain phrases, like 'depression', 'green shoots' trigger mood shift

NEW YORK -- Images of bread lines, soup kitchens and other flashbacks to the Great Depression planted enough worry in the minds of stock investors in early March to cause a selling stampede.

But then signs of hope in the form of economic data that were bad but not as bad as feared — a phenomenon economists dub "green shoots" — sparked a 37% rally in the Standard & Poor's 500-stock index.

This week, stocks have fallen 4% after weak retail sales sparked worries that the green-shoots thesis may not mean a sustainable recovery.

Big market mood shifts bear watching. These types of stock market story lines or media-driven investment ideas, such as the risk of a depression or the more upbeat green-shoots theme, wield huge power over investors, says Woody Dorsey of Market Semiotics, an expert in the psychology of investing.

"Any time a market idea gets propagated, it becomes a fad. It reflects investors' thinking and is used as a rationale to sell or buy stocks," Dorsey says. "In financial culture, you can only have a few good stories at a time, and they are constantly changing."

In a span of nine weeks, investor sentiment did a 180-degree psychological turn.

"We went from people thinking the end of the world was near in October, to Dow 10,000, here we come," says Price Headley, chief analyst at BigTrends.com.

That shift from doomsday thinking (and plunging stocks) to a "we will survive" mentality (and rising stocks) is evident in the number of media mentions of two phrases that conjure up very different emotions: the financial insecurity associated with the term "Great Depression" and the sense of security elicited by the phrase "green shoots."

Investor sentiment, especially the extremes of fear and greed, has historically been a key factor in determining the direction of stock prices. During periods of fear, stocks tend to go down. In periods of unbridled optimism, stocks tend to go up.

"Mood is hugely important to a person's decision-making, whether it be a financial one or what to have for dinner," says Rick Bensignor, chief market strategist at Execution.

But when either emotion hits an extreme, investor sentiment becomes a contrarian indicator. In other words, when fear gets overdone, and people think the market is going to zero, stocks tend to rebound as most sellers are out of the way and lower prices lure in bargain hunters. Similarly, when investors think stocks won't ever stop going up, it can portend a decline.

That classic sentiment shift was evident in the rally off of the March 9 bear market low. A Nexis analysis of the number of media mentions of the terms "Great Depression" and "green shoots" illustrates the massive mood — and price — swing on Wall Street. The analysis runs from September 2008, when Wall Street firm Lehman Bros. collapsed, through the end of April, when fears of a worst-case economic scenario began to fade.

In September, there were nearly 2,400 media mentions of "Great Depression." But just eight hits for "green shoots." Great Depression hits peaked in January, with more than 3,000 hits, but have declined three months in a row. In contrast, green-shoots mentions jumped to 89 in April.

So what is the market's mood now? And what is it telling us?

Bruce Bittles, chief investment strategist at R.W. Baird, says that the still-low readings of "green shoots" suggests that the psychology of investors has not gotten overly optimistic, a fact he says bodes well for a continuation of the stock market rebound.

But Dorsey says the big rally since early March was driven largely by hopes generated by the green-shoots idea. But that upbeat story line may be "played out," suggesting a pullback is possible, he warns. Time will tell, he says, whether the next market story line is bullish or bearish.