BANK OF AMERICA: Stocks could surge 19% this year because investors are the right kind of cautious

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REUTERS/Lucas Jackson

  • For the entirety of the 8-1/2-year bull market, an undercurrent of skepticism has been a secret ingredient in keeping the rally going.
  • While investors have been getting more exuberant over the past few months, they’re still nowhere near a level of extended sentiment that would suggest an imminent pullback, according to Bank of America Merrill Lynch.

Cautious stock traders are unwittingly helping their own cause by not getting ahead of themselves.

A monthly survey conducted by Savita Subramanian’s team at Bank of America Merrill Lynch shows that while an indicator of investor exuberance has risen for a third straight month, it’s still nowhere near extended enough to suggest a downturn is coming.

In fact, when the so-called Sell Side Indicator has been at this level in the past, it has preceded a median 12-month return of 19%, according to BAML data. That would imply a 2018 year-end price of roughly 3,200 for the S&P 500, a target that would be at the top end of Wall Street strategist forecasts.

This chart shows just how far investors are from getting overly exuberant. Only when the Sell Side Indicator climbs above the red line does it flash a “sell” signal – and, as you can see, it’s still a long way away.

BAML's Sell Side Indicator suggests 12 more months of stock gains, to the tune of 19%.

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BAML’s Sell Side Indicator suggests 12 more months of stock gains, to the tune of 19%.
source
Bank of America Merrill Lynch

That this wariness exists at a time when stock indexes are continuing to hit record highs speaks to just how reluctant traders have been to throw caution to the wind when it comes to equities.

As such, the 8-1/2-year bull market, commonly referred to as the “most hated” in history, has kept grinding forward as sentiment has stayed largely in check. And that has allowed investors to focus on the fundamentals, which – between earnings growth, steady economic expansion, and easy monetary conditions – look resoundingly positive.

But that’s not to say US stock investors are out of the woods. All of these factors working in their favor could certainly push them into “extreme bullishness” territory. Also, while the buy and sell signals attached to the Sell Side Indicator are calculated based on a rolling 15-year average, the picture is much starker if you shorten that time frame.

Back in October, BAML pointed out that an alternative methodology based on a four-year mean was flashing a sell signal for the S&P 500. And while clearly no such drop materialized, the firm has long recommended staying hedged against any sort of unexpected shock. Because while historical studies are helpful, there’s no telling what will actually happen in real time.