Investor sentiment in the stock market has taken a notably bearish turn, prompting a contrarian buy signal from a proprietary indicator at Bank of America Corp., suggesting a potential short-term rally in the asset class. According to strategist Michael Hartnett, the Bank of America’s bull-and-bear reading dipped from 2.2 to 1.9 during the week ending on October 18. This shift was primarily fueled by substantial outflows from emerging market debt funds, high-yield bonds, and global equities, coupled with an uptick in cash allocations. A reading below 2 is widely regarded as an indicator of an impending near-term rally.
Historical data from 2002 onwards reveals that in the three months following 20 similar occurrences, U.S. stocks experienced a median gain of 5.4%, while global equities saw an impressive advance of 7.6%, as outlined in a note from Hartnett dated October 19. Despite this potential upturn, Hartnett has maintained a bearish outlook throughout the year, even amidst the earlier surges of the stock market.
Money continues to flow out of the stock market, with money market funds witnessing a record high outflow of $108.9 billion in the week ending October 18, according to Hartnett, citing data from EPFR Global. During the same period, global equity funds faced $5.2 billion in redemptions, while bond funds experienced an inflow of $2.1 billion. Nevertheless, investor sentiment remains pessimistic enough for the S&P 500 to hold steady above the 4,200-point mark and the 10-year Treasury yield to stay below 5%, Hartnett noted.
As of Thursday’s close, the S&P 500 stood at 4,278 points, just above its 200-day moving average, a crucial technical support level, and slightly surpassing the 4,200 target. October has proven to be a turbulent month for U.S. stocks, with bond yields seeing a surge and Federal Reserve Chair Jerome Powell once again indicating the central bank’s intent to maintain current interest rates in the upcoming meeting. Powell’s statements led to a pullback in bond yields, with the 10-year Treasury hovering just below the 5% threshold on Thursday.
The Bank of America fund manager survey revealed a surge in cash holdings among investors who anticipate a slowdown in economic growth. While the immediate outlook for stocks appears optimistic, the long-term prognosis remains uncertain. Should the S&P 500 fail to maintain its position at 4,200 amid the prevailing bearish sentiment, Hartnett suggests there may be potential risks of a credit event or a sharp economic downturn.
In summary, Bank of America’s distinctive indicator points towards an imminent short-term upswing in stocks, amidst a backdrop of cautious investor positioning and an uncertain economic growth trajectory. While this may bring some respite for investors, the future of the stock market remains shrouded in uncertainty.