Aim stocks have done well recently – so much so that the Aim index is close to a seven-year high relative to the FTSE 100. This matters for all investors, whether we own Aim shares themselves or not.
I say this because the Aim index is a measure of investors’ sentiment, and so can help predict returns on equities generally.
My table shows the point. Here, I’ve de-trended the ratio of the Aim index to the FTSE 100, to adjust for the tendency for Aim shares to underperform over time. (Why they do so is another story.) It’s clear that there are reasonable correlations between this de-trended ratio and subsequent annual changes in several indices and sectors. When Aim is high relative to the FTSE 100, small caps, IT, media stocks, the All-Share index and Aim shares themselves tend to do badly in the following 12 months, while tobacco, utilities and food retailers tend to do well. These patterns are much the same if we ignore the tech bubble and burst, or if we look at price changes over periods longer than 12 months.
| How Aim predicts | |
| Correlation between Aim/FTSE 100 ratio | |
| and subsequent annual returns | |
| All-Share index | -0.22 |
| FTSE small caps | -0.37 |
| FTSE Aim | -0.54 |
| Tobacco | 0.44 |
| Food retailing | 0.28 |
| Information technology | -0.61 |
| Media | -0.57 |
| Utilities | 0.28 |
| Based on data since January 1999 | |
There’s a simple reason for this pattern. Aim stocks tend to be hard to value by conventional metrics, because they are often new or unprofitable or are operating in new or unfamiliar markets. For this reason, they tend to be driven even more than most shares by swings in investors’ sentiment. It’s no accident that the de-trended Aim-FTSE 100 ratio peaked during the tech bubble in 2000 and again during the mid-00s, and hit low points in the 1998 LTCM crisis and during the 2009 recession.
Aim shares, then, measure sentiment. And when sentiment is high, shares are vulnerable to a fall. This is partly simply because sentiment tends to mean-revert: the more optimistic investors are, the greater the likelihood that sentiment will change for the worse. Also, high sentiment is a sign that good news might be already discounted whereas bad news is not. That leaves shares more sensitive to nasty surprises than to nice ones.
As you’d expect, the shares that are most vulnerable to these changes in sentiment are those that are themselves more driven by sentiment. These are hard-to-value stocks such as smaller ones, IT and Aim shares themselves.
On the other hand, some shares are inversely related to this sentiment indicator. These are defensive ones such as tobacco and utilities. This is because when sentiment declines, investors tend to rotate back into defensive shares.
Of course, our correlations are well short of plus or minus one. This is only to be expected: stock markets are noisy and no indicator is anything like perfect. Nevertheless, there is some information here. High prices of Aim stocks are telling us that sentiment is high and that – insofar as history is a guide – we should therefore be a little worried about the prospects for smaller and growth stocks (and to a lesser extent the market generally) but more sanguine about the relative prospects of defensive stocks.
