Merrill Lynch: Don’t Follow the Fearful Crowd

What if I told you sentiment was still broadly negative with regards to the future of the economy and the market in general.  Would you really be that surprised?  You’ve probably seen this chart from Merrill Lynch showing the Wall Street consensus equity allocation, but I figured I’d provide a brief update here (via ML):

  • Wall Street’s consensus equity allocation has been a reliable contrary indicator over time. In other words, it has been a bullish signal when Wall Street strategists were extremely bearish, and vice versa.
  • Despite the rebound since hitting an all-time low of 43.9 in July 2012 (based on data since 1985), strategists’ bearishness on equities remains extremely depressed relative to history. At 49.8, the indicator remains firmly in “Buy” territory.
  • Even though the S&P 500 has already risen 22% since sentiment bottomed, historical returns have also been very robust in the subsequent 12 and 24 months after the indicator troughed, averaging 24% and 46%, respectively (Table 4).
  • Historically, when the indicator has been below 50, total returns over the subsequent 12 months have been positive 100% of the time. Current bearish sentiment suggests +22% 12-month price returns.

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Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  • SS

    How useful is this indicator? I see no real applicable use.

  • FXTrader

    Sorry Cullen, but this indicator is useless.

  • fin

    That’s totally in contrary of the impression I got from media, and also totally different from market response.

  • Steve W

    Isn’t that a favorite indicator of Richard Bernstein (who used to work at ML)?

  • Matt

    This chart is not valid. See this Research Puzzle blog post: http://rp-pix.com/mq

  • HankB

    What does that post say other than the numbers don’t add up? This is a contrarian indicator. That’s why they’re wrong. The author doesn’t even seem to understand why something like this might be useful in the first place.

  • Boston Larry

    What is the number of times that this indicator has made a successful prediction? Are there enough instances for it to be statistically significant? Besides, in the short-run, equities may have risen too far too fast. The market has gone an awful long time without even a 5% correction.

  • Geoff

    Regarding US equities, there appears to be a stark contrast between the sentiment of domestic versus foreign investors. Domestic investors still seem fairly bearish, as this chart shows. However, foreign investors are extremely bullish on US stocks. Their US equity allocation is at unprecedented levels. It is a VERY crowded trade. Therefore, I strongly believe that US equities will underperform most foreign markets sooner rather than later. The question is how? Will foreign stocks outpace on the upside in a global bull mkt, or will they simply hold up better than the US in a global bear mkt?

  • Anonymous

    from Hulbert of MarketWatch: http://www.marketwatch.com/story/sell-signal-from-key-market-indicator-2013-07-17?dist=afterbell:
    Mark Hulbert says: A market timing indicator with a stellar long-term record is now in “sell” mode.
    Cullen, what do you think of this timing indicator?

  • mike

    everything you need to know is all in the Japanese candle stick price action