The stock market’s fear gauges point to a bounce, not a bottom

Online searches for it surged just over five years ago, the same week as queries for “sourdough bread" and “adopt a pet" marked the pandemic’s early days. Wall Street’s so-called fear gauge, the Cboe Volatility Index or VIX, also hit an all-time high that week, surpassing its October 2008 record during the global financial crisis. The S&P 500 would go on to a total return of 77% in the following 12 months—one of its best performances ever.

After seeing our 401(k)s turn into 301(k)s last week, it is tempting to look for a widely available barometer for when the bottom is in. Investing isn’t so simple.

Extremes in sentiment are more likely to point to a short-term “sucker’s rally" that serves to crush spirits even more. Take that October 2008 VIX record: Between Oct. 27 and Nov. 6, stocks would bounce by a fifth. Then they lost another quarter over four months.

Given the—sorry—unprecedented nature of the trade upheaval, and the fact stocks aren’t even in a bear market yet, it is a good bet that coming rallies will be of the sucker’s variety. Those still can be lucrative for the speculatively minded, or an opportunity to lighten up on stocks for people who regret not doing so ahead of “Liberation Day." Tread carefully, though.

One gauge likely to plumb new depths is the AAII Sentiment Survey. Each week for decades, the American Association of Individual Investors has asked members if they are bullish, bearish or neutral. Last week’s bearishness was the highest since March 5, 2009, the session before the bear-market bottom. Most responses last week were lodged before the Liberation Day carnage, so a new record is likely.

A more timely “Investor Optimism Index" maintained by Nations Indexes briefly went below one Friday on a scale of 100—a level creator Scott Nations says is “very, very rare." Closes below 10 for the options-related measure have indicated the best returns for the S&P 500 over the following 20 trading days.

Just don’t call what we had a crash, says Nations. Among his four books, two on options math, is “A History of the United States in Five Crashes." Trading was wild last week, not discontinuous.

His most recent book, “The Anxious Investor," which fuses history and behavioral finance, gives an unsatisfying answer about how to handle today’s mayhem. As tempting as it is to feel in control, it warns that these are the times we’re likely to make the most harmful and irrational decisions.

Measures of individual investor returns confirm that less is more. There is a costly gap between how our portfolios do and how they would have done if we set and forgot them. The widest gaps come during the most turbulent months.

Even those disciplined enough to sit still will wonder how far this goes and when it ends. The Covid-19 bear market, the shortest in history, probably provides a misleading guide. The government throwing everything but the kitchen sink at it turned sentiment around. This time around, to use the horror-film trope, the call is coming from inside the house.

If this becomes a severe bear market then the bottom will come at the point of capitulation when investors are disgusted with stocks. We are just too recently removed from a positive peak in sentiment and AI optimism.

As we will probably soon relearn, markets don’t go down in a straight line. But they go down a lot more than we might imagine.

Write to Spencer Jakab at Spencer.Jakab@wsj.com