The bad news bears are back in town, and that could be good news for U.S. stock market bulls.
With so many market experts predicting that the S&P 500 SPX -0.29{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} is set for a 20{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} slide, and the small-stock Russell 2000 will fare even worse, it’s easy to ignore one closely watched investor sentiment measure that keeps flashing a bright “buy” signal.
Bank of America Merrill Lynch’s proprietary “Sell Side Indicator” — the average recommended equity allocation of Wall Street strategists — puts Wall Street’s bullishness at a 13-month low. In fact, pessimism is even more extreme than at the market lows of March 2009. In true contrarian fashion, this is positive for U.S. stocks , BofA Merrill says — to the tune of a 22{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} total return over the next 12 months.
“Given the contrarian nature of this indicator, we remain encouraged by Wall Street’s ongoing lack of optimism and the fact that strategists are still recommending that investors significantly underweight equities, at 51{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} vs. a traditional long-term average benchmark weighting of 60-65{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce},” Savita Subramanian, the firm’s head of U.S. equity and quantitative strategy, wrote in a research report published Friday. The Sell Side Indicator would give a “sell” signal when strategists raise their recommended stock weighting to 66{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce}.
After the grilling stock investors got in July, it’s difficult to fathom the S&P 500 at 2313 at the end of July 2015, but that’s what the Sell Side model currently predicts — though this is not the firm’s official S&P 500 target. Moreover, when the Sell Side Indicator has been this low, total U.S. market returns over the next 12 months have been positive 100{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} of the time.
Adds Subramanian: “Even though the S&P 500 has risen by over 40{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} since sentiment bottomed in 2012, history suggests that strong equity returns can last for years after the indicator troughs.”