Bank of America’s contrarian stock indicator, which has a devoted following, signals that we may well be on the brink of a sharp sell-off. Perhaps as a result, the stock market had a small downturn Tuesday, with the S&P 500 falling 0.8%.
The so-called Sell Side Indicator, constructed using analysts’ calls every three months, is in a bullish mode now. The idea behind this gauge is that, when sentiment is bullish, that’s a sell warning. And vice versa for when the groupthink is bearish.
By this metric, the market indicator (of how bullish these analysts are) is just 1 percentage point away from a too-optimistic-for-its-own-good sell signal, the report declared. “We’ve found Wall Street bullishness to be a reliable contrarian indicator,” wrote Savita Subramanian, equity and quant strategist at BofA Securities, and her team.
The note said the indicator has been more accurate vis-à-vis 12-month S&P 500 returns than other popular market timing models, such as the Fed Model. The latter yardstick compares expected corporate earnings yields and those of Treasurys, and it has zero to do with the Federal Reserve.
The BofA indicator last emitted a stark warning signal in June 2007, the report said. Stock returns averaged minus 13% on an annualized basis in the three years after the jeremiad. The report doesn’t reveal the timespan, but that’s how the math works out.
There are plenty of bullish conditions around. Yesterday saw the easing of the strong rise of the benchmark 10-year Treasury yield—when bond yields are going up, it’s often thought to be not good for equities.
What’s more, regulators have approved the deployment of Johnson & Johnson’s COVID-19 vaccine. And, on the Washington front, the odds appear good that the Biden administration’s $1.9 trillion relief package will win Congress’ approval.
The Sell Side Indicator rose to 59.2% from 58.4% in February, growing more optimistic. This is near its highest point in a decade and close (1.1 point away) to the statistical sell threshold, by BofA’s reckoning.
Nevertheless, Treasury yields are indeed trending upward and stock valuations are lofty. Although 10-year T-note yields have descended from a peak of 1.61% last week, a climb back above that could propel investors to shift into bonds from stocks, the report said. And stocks’ high price-to-earnings (P/E) multiples indicate below-average annualized returns of 7% or so in the future, according to the bank.
The report also includes other caveats—such as that the indicator might only be flagging that tepid market increases lie ahead, as opposed to a slump, perhaps with gains on the order of 7% yearly. This level would be short of the double-digit returns the S&P 500 has generated over much of the past five years (big exception: 2018’s negative 4.4%).
Diehard stock investors would be best served favoring sectors “tethered to the real economy,” the strategists said. In other words, cyclical, value, and small-cap stocks, which BofA feels outperform as the economy reopens. Avoid the long-dominant growth names, the bank’s strategists admonished.