Investor Fear Points to More Upside in Stocks

Fear is taking over...

The S&P 500 Index is in its worst pullback since the March 2020 bear market. We nearly hit an official correction. And for some investors, that was enough to turn greed into all-out panic.

By one measure, investors recently became the least bullish they've been since the 2020 crash. The recent market action scared them. But history shows that we shouldn't buy into their fear.

Instead, we want to take the opposite stance today. That's because a 15% gain is likely in the S&P 500 based on this huge amount of negativity.

Let me explain...

Sentiment is on a hair trigger these days. Stocks fall for a few weeks... And no matter how big or small the decline, investors head for the hills.

This time, the S&P 500 fell 9.8%. But if you poll investors, they're almost as scared as they were during the 34% bust in 2020.

That's according to the American Association of Individual Investors ("AAII") survey...

AAII sends out the survey each week. The goal of the survey is to see what investors think the market will do over the next six months.

For the survey, investors must declare themselves to be bullish, bearish, or neutral. And the latest fall drove investors to huge levels of fear... In the survey out January 19, just 21% of these investors were bullish.

At that point, stocks were still only partway through their slide – down just 4.5% from their peak. Yet it was the lowest bullish reading in 18 months.

To see what this means for stocks going forward, I looked at every time the AAII bullish reading dropped to 21% or less. That has only happened 3% of the time going back to 1987. Importantly, 97% of those instances led to gains in the S&P 500 over the next year.

That's a huge win rate backed by decades of data. And it's no surprise that buying after setups like these crushes a buy-and-hold return over the same period. Check it out...

Since 1987, the S&P 500 has typically returned 8% annually. That's a pretty good way to grow your wealth. But the recent sentiment setup offers much higher gains...

Similar cases have led to 6% gains in three months, 10% gains in six months, and a 15% gain over the next year.

That beats the return you'd have made buying stocks in 1987 and holding them until today... by a wide margin. And it means that falling for investor fear right now is a bad call.

In short, the recent pullback spooked investors. Bullishness recently hit its lowest level in a year and a half. But now isn't the time to be scared.

On the contrary, you want to be greedy today. More gains are likely in the S&P 500 thanks to this setup.

Good investing,

Chris Igou

Further Reading

"Fund managers have been trying to spot the next big risk to the market for years," Chris writes. Right now, investment pros are sounding the alarm. But history shows you shouldn't let them scare you out of the market... Get the full story here: The Investment Pros Cry Wolf Once Again.

When investors run for the exits, it's often an indicator that an asset is ready to bounce back. Right now, investors are fleeing this sector en masse. That tells us we could see major upside over the short term... Read more here: Hunting for Upside in This Oversold Sector.

Market Notes
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