Stock Gauge That Called Past Market Bottoms Flashes Buy Signs

(Bloomberg) -- For the first time since the immediate aftermath of the pandemic bear market, there are fewer bulls than bears in the equity market. That could be good news for Wall Street traders betting on a recovery in the S&P 500 even as the Russia-Ukraine conflict rages.

The latest Investors Intelligence survey of newsletter writers shows those classified as bullish fell to 29.9% while the proportion of bears increased to 34.5%. It's the first since April 2020 that the bull-bear ratio fell below 1.

Similar readings have occurred six other times since 2010 -- all taking place near the bottom of a major market selloff.

“Historically, we're in a zone where tradable lows and above average forward returns take hold,” Chris Verrone, head of technical analysis at Strategas Securities LLC, wrote in a note to clients. “It's helpful contrarian data.”

Trepidation has grown after a two-month selloff that wiped out as much as $7 trillion from U.S. equity values, sending the tech-heavy Nasdaq 100 to the brink of a bear market and the S&P 500 into a 10% correction. Stocks tumbled amid concern that a cacophony of risks -- from inflation to tightening monetary policy and a raging war in Ukraine -- would derail the global economy.

The S&P 500 fluctuated in Thursday trading after an unexpectedly weak reading in the U.S. services sector.

Evidence of poor sentiment is easy to find. Hedge funds tracked by Goldman Sachs Group Inc., for instance, have cut their equity exposure to the lowest level since June 2020. In a poll by the National Association of Active Investment Managers, an index of their stock exposure fell this week to levels not seen in almost two years.

Still, not all indicators suggest a bottoming in sentiment. As pointed out by Verrone at Strategas, options traders aren't rushing for protection. The Cboe put-call ratio stayed subdued last week, when the S&P 500 dropped to fresh lows.

Similarly, the New York Stock Exchange Short-Term Trading Index, a volume-based guage known as TRIN, has stayed below two during the market's latest leg down -- a level that Verrone watches for sentiment washout.

“We get that the utility of indicators change over time and from regime to regime, but we're nevertheless surprised put/call ratios have been so benign over recent weeks,” he said. “TRIN hasn't expressed much urgency either.”

But should the U.S. expansion hold -- as projected by economists in a Bloomberg survey -- bears would be forced to capitulate, spurring a market recovery.

“Extreme bearish sentiment tends to be extremely bullish,” said Ed Yardeni, the president of Yardeni Research Inc. in a note. “Notably, those readings don't rule out further near-term declines in the S&P 500. However, they do suggest that buying bargains now makes sense for long-term investors.”

Read: Yardeni Sees Chance That Stagflation Proves Best Case for Stocks

The Investors Intelligence survey ended 98 weeks in which bulls dominated, the longest run in data going back to 1970. If history is any guide, now may be the time to go against the herd and buy stocks, a study by Sundial Capital Research suggested.

Prolonged bullish sentiment has flipped like this 13 other times -- 11 of which saw the S&P 500 rallying over the next two months, Sundial data show. The two exceptions occurred in the 1970s.

It's “best to fade the majority of newsletters,” Jason Goepfert, chief research officer at the firm, wrote in a note. “While we prefer to see optimism rising instead of falling, by the time that pessimists accounted for the majority of newsletters, most stock declines were behind us.”