US stocks have been trading sideways near record highs for nearly four months, with gains frequently erased by subsequent sell-offs, as seen on Monday. This persistent volatility has shifted a closely-watched investor sentiment survey: bearish respondents have outnumbered bullish ones for the first time since last November. Additionally, Deutsche Bank strategist Parag Thatte noted that the bank's measure of active equity positioning has moved to an underweight stance.
Combined, these seemingly pessimistic signals are actually flashing green for perennially optimistic stock market bulls. Historical precedent suggests they can anticipate a rebound in equity buying. The signals also indicate a broadening rally, as investors continue rotating out of mega-cap technology stocks into higher-risk small-caps and emerging markets.
Ed Clissold, Chief US Strategist at Ned Davis Research, stated that the market currently exhibits a "rare combination of pessimism and strong market breadth." He informed clients on Monday that this setup is "overall positive" for US equities and "a key reason we maintain an overweight allocation."
The S&P 500 is down 0.8% from its peak on October 28 last year, a record set before a prolonged pullback in the "Magnificent Seven" tech stocks in November. The index last closed at a record high four weeks ago and was down 2% from that level at Monday's close.
Year-to-date, both the Russell 2000 index and the S&P 500 Equal Weight Index have gained at least 5.2%, as investors shift capital from super-sized tech stocks into smaller, riskier equities, as well as the energy, materials, and consumer staples sectors.
Despite this, Andrew Greenebaum, Senior Vice President of US Product Management at Jefferies, noted in a client report that "sentiment and exposure have fallen off a cliff." He wrote, "We may struggle to see signs of 'buying with a peg on their nose'—and we're not even sure that's possible, given the benchmark index hasn't even entered correction territory."
Beyond the growing pessimism, which is often viewed as a contrarian indicator, bulls point to more concrete reasons for optimism. Chief among these is corporate earnings. Data compiled by Bloomberg Intelligence shows S&P 500 companies reported a 13% profit growth for the fourth quarter, exceeding expectations of just under 9%.
While the American Association of Individual Investors (AAII) survey results are clearly bearish, there is a sense that respondents, much like in other sentiment surveys such as consumer confidence, are "talking their book" rather than acting on it. Matt Miskin, Co-Chief Investment Strategist at Manulife John Hancock Investments, remarked, "They say 'we're not that bullish,' but look at what they're doing—they are adding risk exposure."
Miskin pointed out that examining the market's internal structure reveals investors have been flowing into riskier stocks. They are also using products like leveraged single-stock ETFs to bet on larger gains. He noted in a phone call that retail investors have been "buying the dip, and doing it very successfully."
Greenebaum highlighted several positive developments from the recent earnings season, including nearly half of S&P 500 companies raising their guidance—the highest proportion since the second quarter of 2021. "These companies aren't broken; they are growing. It's just that people are choosing not to acknowledge them now, but I suspect that will change in the medium term," he said. "I would be shocked if we don't see the market begin to churn higher."
Specifically, he noted that a Ned Davis Research sentiment index fell into pessimistic territory on February 11. Concurrently, even after the extended rotation from big tech into value and small-to-mid-cap stocks, over 62% of S&P 500 constituents remain above their 200-day moving average. Furthermore, the S&P 500's Advance/Decline line is at a record high. He wrote, "These criteria seem to capture a mature bull market, not an impending crash, though it also doesn't feel like the start of a major rally."
Investors are also contending with rising policy uncertainty, following the US Supreme Court's rejection of former President Trump's tariff policy, which was hastily revised last Friday. Ongoing concerns that new AI tools could erase revenue streams for a range of companies continue to pressure the market.
Dirk Willer, Head of Macro Strategy and Asset Allocation at Citi Global Markets, stated in a recent client note that the S&P 500 is trading in a "messy range," and the bank's own sentiment indicators "suggest some tactical caution." Nonetheless, the firm reiterated its overweight stance on US equities while reducing exposure to tech stocks, reallocating 50% of that holding to small-caps. Willer said, "Our equity strategists believe this broadening market breadth has further room to run."
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