As U.S. equity markets continue to post record highs, a further indication that the good times aren’t over came Tuesday with Bank of America’s monthly Sell Side Indicator report.
The report, which measures the bullishness of Wall Street analysts, fell 0.1 point, to 56.3 remaining in “Neutral” territory where it has been for the entire 2017, a territory that has proved lucrative for equity investors. “Historically, when our indicator has been this low or lower, total returns over the subsequent 12 months have been positive 94% of the time, with median 12-month returns of +19%,” Bank of America said.
The indicator acts as a contrarian indicator, meaning when analysts are bearish contrarian traders think it is a good time to buy. Bullishness has been rising on Wall Street, but it remains well below “Extreme Bullishness” territory, a possible danger zone for stocks. (See also: 3 Dividend Stocks That Outperform the Big Techs.)
Contrarian trading is the art of “going against the grain,” buying when the market consensus is to sell or vice versa. One of the most notable contrarian traders is the Oracle of Omaha Warren Buffett. He believes investors should not lose sight of the long-term prospects for a stock in the face of short term adversity, much like he did with his purchase of Apple Inc. (AAPL) in 2016.
As shares in Apple crashed below $100 for just the second time since 2014, the consensus at the time was for Apple to continue lower. Prominent hedge fund investor Carl Icahn famously sold all his Apple shares at the time. However, Buffett saw value in Apple stock as some long term metrics fell to levels that made the stock an attractive buy. For example, Apple’s p/e ratio traded below 12, at the same time the p/e ratio of the S&P 500 was 22.8. (See also: Buffett and Icahn’s Take on Apple.)
The Bank of America contrarian indicator has a fine record. In 2009, at the bottom of the Great Recession sell-off, the indicator entered “Extreme Bearishness” levels, which is bullish for stocks. “We have found that Wall Street’s consensus equity allocation has been a reliable contrary indicator. In other words, it has historically been a bullish signal when Wall Street was extremely bearish, and vice versa,” Bank of America said.
The Wall Street consensus indicator is proof that even the experts are not always correct. It often takes a brave trader to do what every other investor is not doing, but it often has its pitfalls. Since Buffett made his purchase in Apple, shares in the tech giant have risen by more than 60 percent. However, like all trading strategies, nothing is fool-proof.
“Past performance is not an indication of future results,” according to Bank of America.