There is this contrarian indicator called the "Bank of America Merrill Lynch's Sell Side Indicator", which has just started to look extremely bullish - in fact the most bullish in 15 years.
What is This Indicator
This indicator is based on the average of equity allocation of analysts at the Wall Street, at the end of the month, and it measures the bullishness and bearishness of the stock analysts. The chart below shows this indicator as of 06/30/2012.
So what has been going on?
Thanks to the global financial troubles, there has been an increased paranoia around equities. Equity allocation in analyst portfolios have dropped to record levels because analysts are moving to other investment instruments in trying to save themselves and their clients from another doomsday scenario.
The equity allocation has been so dismal that the benchmark allocation of equities has fallen to about 50% from its otherwise normal 60%+ levels.
A similar situation arose in the 1990s when analysts were getting prepared for a stock market doomsday scenario. Investors who sold then at losses probably got so burnt they may have stayed away from the stock markets for the rest of their lives or at least for quite a while.
Amidst this extreme bearishness, any surprise in the market, be it something like today's factory orders, could cause a major uptick in the market. And any negative news like the ISM Index's dismal figures might not cause the same level of downside at the same time.
Basically sell-side analysts' bearishness have become more extreme than the bearishness during the recent housing bubble and the tech bubble in late 90s.
According to their recent announcement, analysts at the Bank Of America's Equities Strategy unit said,
Given the contrarian nature of this indicator, we are encouraged by Wall Street's lack of optimism.
12 Month Price Target for S&P 500 Based On This Indicator
If the Bank Of America analysts at their Equities unit use only this indicator to estimate the 12-month target for S&P 500, the figure would be around 1665! Note that officially declared price targets are estimated by such firms based on a combination of multiple indicators, not just one.
What should investors do?
Stick to your basics - reports like these are only worth taking note of and should not be the basis for making impulsive decisions.
July, especially the first half, has historically provided greater returns for the S&P500, and then the rally has quickly faded away into chopping markets till September. If history were to repeat itself, and there is no guarantee it will, investors can decide to start getting some protection during late July and trim lesser quality stocks to take profits.
Stick to your fundamentally sound investments and they will pay off well in the Q4 rally which is in fact historically the strongest rally of the year.