Is a bearish stock market strategist a bullish indicator? That is exactly how some observers interpret the overall impressions on Wall Street and Bay Street: When the pros are shying away from stocks, the market could be set to rise.
For sure, Wall Street strategists are a grumpy lot these days, according to their recommended allocation toward stocks. Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America, pointed out that this allocation increased slightly in August for the first time in six months, but it remains near its lowest level for data going back to 1985.
As a group, these strategists recommend a mere 44.4 per cent exposure to equities right now. That's down from a long-term average of 60 to 65 per cent, and a high above 70 per cent during the early days of the technology-fueled bear market in 2001. This sentiment indicator is even lower than the reading in 2009, when the S&P 500 was still plummeting in reaction to the financial crisis and global recession.
But if the brightest folks on Wall Street are fearful of stocks right now – driven by a debilitating recession in Europe, a weakening Chinese economy and deteriorating U.S. conditions – the contrarian thinking is that this is potentially good news for the market. It suggests that a lot of money is sitting on the sidelines amid low expectations, and this money could come flooding in at the first sign of better-than-expected news.
Ms. Subramanian backs up this approach with impressive numbers: When the sentiment indicator has been below 50, she noted, total returns over the next 12 months have been positive 100 per cent of the time. Even better, the average 12-month gain has been more than 30 per cent.
In other words, with current sentiment well below 50, the S&P 500 could be on the verge of spectacular gains over the next year.
"We are encouraged by Wall Street's lack of optimism," Ms. Subramanian said in a note. No wonder: Taken on its own, the indicator implies a rise to 1,831 for the S&P 500 within the next 12 months, which would be deep into a new record high.
Still, you can be forgiven for not rushing to buy stocks just because Wall Street strategists are shying away from them. Even Ms. Subramanian cautions that the sentiment indicator is just one of many models used in coming up with her target for the S&P 500. That target is 1,450, or just 3.6 per cent above the current level – suggesting that she, too, could be her own contrarian indicator.
That said, other strategists are even more cautious about where the S&P 500 is headed. According to Bespoke Investment Group, the consensus expectation among strategists is for the S&P 500 to end the year at about 1,386 – or about 1 per cent below the current level.
Meanwhile, retailer investors also sound nervous. According to the latest reading from the American Association of Individual Investors, just 34.7 per cent are feeling bullish – considerably below the long-term average of 39 per cent and down from a reading above 50 per cent near the start of the year.
So if small investors aren't embracing stocks and the pros aren't either, you have to wonder who has been driving the S&P 500 up 11.4 per cent this year. No wonder the extraordinarily low trading volumes have become a source of concern.