This closely watched stock-market indicator hit a 2.5-year high. What it says will happen next.

MW This closely watched stock-market indicator hit a 2.5-year high. What it says will happen next.

By Isabel Wang

BofA strategists caution that elevated market sentiment could limit upside for the S&P 500 - advising investors to 'stay selective' in stock investing

Wall Street was growing more bullish in the final weeks before the Nov. 5 presidential election - a contrarian sign that may suggest limited upside for U.S. stocks, according to BofA Global Research.

BofA's Sell Side Indicator $(SSI)$, which tracks Wall Street strategists' average recommended equity allocations, in October climbed to its highest level in more than two-and-a-half years (see chart below). The sentiment gauge rose 50 basis points to 56.7% last month, resuming its climb after pausing in September, a team of BofA strategists led by Savita Subramanian, head of U.S. equity and quantitative strategy, said in a Friday client note.

But that may not actually be a good thing for stocks. The BofA team has long touted the SSI as "a reliable contrarian indicator" since an overly bullish sentiment may cause some investors to take an opposite view - when everyone else in the stock market is optimistic, it is often a good time to sell.

Despite the bullish tilt in October, the SSI remained in "neutral" territory - but it was just 1.4 percentage points shy of a contrarian "sell" signal, Subramanian and her team said.

"Its current level of 56.7% suggests a price return of 11% for the S&P 500 SPX over the next 12 months, much lower than recent history, but still roughly in line with the market's annualized return over the past decade," the BofA strategists wrote.

However, investors may want to seize this opportunity to "stay selective" and focus on "more unloved" areas of the market, such as high-dividend-yielding stocks, large-cap value stocks and cyclicals, Subramanian and her team said.

See: Trump-Harris election may take weeks to decide. Here's what investors must know.

To be sure, the heightened stock-market sentiment coincided with a challenging month for the market, as investors prepared for a hectic stretch with new economic data, third-quarter corporate earnings, the Federal Reserve's policy meeting and the election. The S&P 500 and the Dow Jones Industrial Average DJIA in October suffered their worst month since April, while the tech-heavy Nasdaq Composite COMP posted its biggest monthly decline since July, according to Dow Jones Market Data.

Republican Donald Trump and Democrat Kamala Harris will continue to have the stock market's attention next week as the two candidates remain neck-and-neck in the polls with just days to go until the election.

How a too-close-to-call race for the White House will lift - or dampen - stock-market sentiment is still anyone's guess, said Jeff Grills, head of U.S. cross markets and emerging-markets debt at Aegon Asset Management.

"What typically causes markets to underperform is uncertainty, especially after election night," Grills told MarketWatch on Friday. "The longer the uncertainty lasts, the more concerned investors might be about it, which could lead to risk aversion in the stock market.

"But markets should return to focusing on fundamentals and get past the election process once there's more certainty on which candidate [wins the election] or what the government looks like," he added.

See: Squinting for good news in a bad October jobs report? Here it is.

U.S. stocks were surging on Friday afternoon after a weaker-than-expected October jobs report seemed to increase the possibility of more aggressive interest-rate cuts from the Fed, while shares of Amazon.com $(AMZN)$ were leading a rally in megacap technology stocks.

The Dow was jumping over 300 points, or 0.8%, while the S&P 500 was up 0.6% and the Nasdaq was advancing 0.8%, according to FactSet data.

-Isabel Wang

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

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November 01, 2024 14:54 ET (18:54 GMT)

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