The strange reason why stocks may soon surge

Here's a bullish sign for stocks: Investors don't see too many bullish signs for stocks.

According to the American Association of Individual Investors, which uses polling data to generate a sense of investor sentiment over time, bullish sentiment has fallen to 20 percent, which is the lowest it's been since April 2013. Meanwhile, bearish sentiment has risen to 33 percent, and neutral sentiment remains at historically elevated levels.

"Bullish sentiment readings below 28.6 percent are unusually low, and unusually ow levels of optimism have typically been followed by better-than-average six- and 12-month returns for the S&P 500," the AAII wrote in a Thursday note.

The basic idea behind the use of sentiment as an indicator is that bullish investors have already bought in, and neutral or bearish investors are underallocated to equities. As they come around, these skeptical investors will jump into stocks, driving the market higher. (For the converse reason, excessively bullish sentiment is generally taken to be a bearish indicator.)

A technical look at the market yields a similar take on sentiment, according to Evercore ISI's Rich Ross—though he emphasizes that measuring market sentiment is a sensitive endeavor.

"Sentiment is a qualitative factor which is notoriously difficult to quantify," he wrote to CNBC. "Despite these drawbacks, sentiment measures have proven useful at extremes in identifying critical market turning points."

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Ross measures sentiment by looking at so-called market internals. Specifically, he examines the percentage of stocks that are above their 50-day moving averages.

"When too many investors are bearish, it is likely to coincide with very low levels of stocks above their moving averages as the selling pushes them down beneath these levels," he explained.

Looking at that metric, Ross finds that the percentage of S&P 500 stocks above their 50-day moving averages has fallen to its lows for the year, and is recovering off of those levels.

The last time the number of stocks above their 50-day moving averages fell to that level, "the market rallied 5 percent," Ross said. And right now, "I think we're set up for a nice summer rally here. There are too many bears, and the data is simply getting too good here."

However, for David Seaburg, head of equity sales trading at Cowen & Co., sentiment is a somewhat less important indicator now than it has been in the past.

"The corporate buybacks have really done a lot in terms of driving stock prices higher. And I think that they are really supporting this market in a way that's, oddly, very different than in the past," Seaburg said in a Thursday "Trading Nation" interview. "So when you say 'individual investors,' I understand it, but you've got to realize the other driving force in this market today is the corporations buying back their own stock because rates are so low."

As rates rise, Seaburg sees buybacks slowing—and for that reason, "I don't see the market really taking off from those levels."


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