The S&P 500 Just Flashed a Rare Buy Signal. History Tells Us What Happens Next.

When the atmosphere becomes truly gloomy, a certain kind of silence descends upon trading floors. A slower, heavier feeling that develops over weeks, when the selling feels almost methodical and the bullish voices become noticeably fewer, rather than the dramatic panic of a single bad day. That’s about where markets are at the moment.

The combination of rising oil prices, persistent inflation, and new geopolitical tension has driven traders toward Treasuries and gold, and the S&P 500 has dropped in five of the last six weeks, losing more than 5% of its recent high. secure harbors. When investors have lost faith in the open water, they turn to this type of investment.

And yet. A contrarian buy signal, and a relatively uncommon one at that, is something that seasoned market observers often circle silently with a red pen amid all that gloom.

Since 1987, the American Association of Individual Investors has conducted a weekly sentiment survey. For nearly forty years, regular investors have responded to this straightforward question: Do you think the market will be higher, lower, or roughly the same in six months? 51.4% of respondents said lower as of early April. pessimistic. When you consider the historical background, that figure doesn’t seem shocking.

Only approximately 98 weeks, or 5% of all weeks surveyed, have readings above 50% bearish since the survey’s inception. It’s not typical. When it occurs, the markets are typically in a truly uncomfortable state, and most people who are sitting at their desks and looking at their portfolios can sense it viscerally.

The pattern that tends to follow this signal is what makes it worthwhile to pay attention to. The S&P 500 has historically returned an average of 10% over the next six months and roughly 16% over the next year when bearish sentiment has surpassed that threshold. Data supporting that for almost 40 years is not insignificant. It’s possible that things will turn out differently this time around—signals fail, conditions change—but it’s difficult to ignore the historical significance of those figures.

Observing all of this makes it difficult to ignore how uncomfortable the contrarian reasoning seems. The data indicates that stocks have historically experienced their most significant recoveries during periods of extreme pessimism. In this way, markets have a long history of dehumanizing consensus. Those who missed the turn were frequently the ones who were most certain the bottom hadn’t arrived.

Remarkably, Wall Street’s own forecasters are taking a different path to reach a similar destination. The S&P 500 is expected to rise by roughly 16% from its current level of roughly 6,595 by December, according to the median year-end target set by major analysts. Barclays actually moved in the opposite direction, increasing its forecast to 7,650, while J.P. Morgan lowered its target to 7,200 due to worries about the Iran conflict. The majority remained unchanged.

At the very least, it’s an intriguing coincidence that such a rough consensus arrived at nearly the same number as the historical AAII signal. At most, it implies that, contrary to what the sentiment numbers might suggest, the fundamental case for stocks hasn’t quietly collapsed.

The technology industry plays a significant role in that debate. Tech companies’ earnings are expected to grow by 43% this year, up from a robust 28% last year, according to analysts. These are the kinds of numbers that, if they come to pass, would provide the larger index with genuine structural support—that is, a rally supported by actual earnings rather than just mood and momentum. Still, that’s a forecast, and forecasts have a stubborn habit of drifting away from reality.

Wall Street’s median year-end forecast for the S&P 500 has been 16 percentage points off from the actual result over the last four years. The world continues to produce surprises that no model can fully predict, not because the analysts are negligent.

The risks that exist now are significant and should be identified clearly. Inflation will persist if oil prices remain high for longer than most anticipate. The Federal Reserve maintains higher rates for a longer period of time when inflation persists.

Higher rates for longer periods of time reduce consumer purchasing power, impede economic expansion, and ultimately squeeze corporate margins in ways that occasionally manifest sharply in earnings reports. In that case, by autumn, the optimistic predictions appear embarrassingly inaccurate.

However, it seems that before all the facts are known, the market tends to price in the worst-case scenario of every story. Although the Iranian situation is grave, most analysts predict that its direct economic effects will be minimal and transient. If that reading is accurate, the current pullback begins to resemble the kind of air pocket that investors wish they had handled as an entry point in retrospect rather than the start of something longer.

Nobody is certain of what will happen next. That has always been true, and it is particularly true at the moment. However, a wall of analyst forecasts pointing in the same direction, a rare sentiment reading, and nearly 40 years of data add up to something worth considering rather than discounting. There has been a flash of the signal. At least history seems to know what typically occurs next.