The Contrarian Bet Is That Stocks Will Rally

The market has a habit of doing the opposite of what most folks expect...

More important, it tends to do the reverse of what most have positioned for.

You might have heard this referred to as the "pain trade." That simply means the market has a habit of inflicting the most amount of pain possible.

So if everyone's betting on a rally... the most pain comes in the form of stocks falling.

The opposite is also true. If everyone is betting on a crash... the pain trade will be a market rally. And that's the exact setup right now.

Sentiment among a specific group of traders is at one of the worst levels we've seen since 2010. That means the pain trade is likely to be to the upside. And stocks could jump 25% as a result.

Let me explain...

Plenty of folks are debating whether a new bull market has arrived. After all, stocks have come a long way: The S&P 500 Index bottomed a little more than six months ago. And it's up 14% since then.

Given that run higher, you'd expect sentiment to be improving. But it's not. In fact, sentiment has gotten worse.

This bearishness is why the pain trade is set up for higher prices today. We can see it by looking at the Commitment of Traders ("COT") report...

The COT is a weekly report that tracks the real-money bets of futures traders. It also tends to be a useful contrarian tool. When these folks crowd into bearish trades, a rally tends to follow. (That's the pain trade in action.)

Today, sentiment among speculators has tanked. That's according to the COT report for the E-Mini S&P 500. These contracts are just smaller versions of the typical S&P 500 futures contracts. And they're showing that futures traders are betting against the market in droves. Take a look...

As you can see, this is the third-most-negative reading since 2010. And it's clear that futures trades aren't preparing for a market rally. Instead, they're betting that stocks will fall from here.

Based on history, though, betting alongside them isn't a good idea today.

I looked at each time the E-Mini S&P 500 COT reading fell below negative 275,000 and then rose back above that level. And as the table below shows, those instances were great times to buy stocks...

The COT reading has only been this bearish three other times since 2010. Those cases included the two best buying opportunities over that period... the near-bear market of 2011 and the 2020 pandemic crash.

The instance in 2015 wasn't quite as impressive for investors. But overall, you can't argue with the results.

On average, buying after these kinds of setups led to 5.2% gains in three months, 13.6% gains in six months, and 24.7% gains in a year. That's more than double the typical buy-and-hold return for each time frame.

These are downright impressive returns. They also highlight what's possible from here, given that the most likely pain trade right now is for much higher stock prices.

Futures traders are incredibly bearish today... And that's despite solid stock performance over the past six months. That means the contrarian bet is that this stock rally will continue.

Good investing,

Brett Eversole

Further Reading

"It doesn't take much to give Mr. Market a good scare," Bryan Beach writes. Of course, it isn't easy to buy when everyone is fearful. But irrational prices don't stay irrational forever – and these contrarian setups can be some of the most lucrative opportunities you'll ever find... Learn more here.

"When the bull market emerges, it'll be a powerful one," Brett says. That's because when everyone is sitting on the sidelines, it means a lot of cash is just waiting to pour back into stocks. And one measure shows that's the exact situation we're in today... Read more here.