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(Spencer platt/Getty Images)
(Spencer platt/Getty Images)

Equity Outlook

The contrarians smell a bull rally Add to ...

Suddenly, everyone is turning bearish - and that's potentially good news for investors who like to buy stocks when no one else wants them.

Merrill Lynch's fund manager survey for July found that a majority of respondents believe that the global economy will deteriorate within the next 12 months, reflecting a growing consensus that the recovery is stumbling.

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According to the survey, a net 12 per cent of managers were bearish on the economy (that is, bearish responses outnumbered bullish responses by 12 per cent), which represents a sharp reversal. Just two months ago, a net 42 per cent of managers expected a stronger economy within the next 12 months.

There were other bearish signals in the survey. Money managers said they had increased their cash levels to 4.4 per cent, which is pretty high for this equity-investing crowd. And a net 39 per cent of respondents said that the risk exposure within their portfolios is lower than normal, the most risk-averse reading in more than a year.

If the pros are shunning stocks, does it make any sense to bet against them? As Merrill Lynch equity strategists Gary Baker and Michael Hartnett pointed out, the survey's results look a lot like March, 2009.

Then, bearishness also prevailed among money managers (and just about everyone else). But the month also marked the bottom of the stock market's steep decline, meaning that pessimism prevailed at a time when it paid to turn optimistic.

This most recent survey could mark a similar turning point in the market's fortunes. It certainly coincides with the most tumultuous period for stocks since the market began to recover 16 months ago.

From late April until the start of July, the S&P 500 slid a total of 16 per cent - putting it deep into correction territory - as investors fretted over the European debt crisis, the impact of incoming government austerity measures and a rash of soft economic data.

The bearishness among the pros is also part of a wider trend. Last week's survey by the American Association of Individual Investors found that bearish sentiment among retail investors rose above 57 per cent. That, too, is the most bearish reading since March, 2009.

And according to research firm Investors Intelligence (via Bespoke Investment Group), even financial advisers are feeling out of sorts these days: Nearly 35 per cent are bearish, which is the highest reading since July, 2009. At the start of this year, a mere 15 per cent of advisers were bearish.

But widespread bearishness can feed contrarian instincts among some investors. If everyone is shy of stocks, it can mean that expectations are low and money is on the sidelines, waiting to drift back in at the first sign of good news.

On Monday, Merrill Lynch's Mary Ann Bartels, head of U.S. technical analysis, noted that rising bearish sentiment among investors and newsletter writers fed into her belief that stocks were due for a rally in July.

Since the start of the month, the S&P 500 has embarked upon a remarkable six-day winning streak, rising 6.5 per cent in total. Maybe bearishness is just what the market needs.

 

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