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Indicator with 100% success rate predicts huge rally for stocks

Just how bearish are Wall Street strategists right now? So bearish that stocks are about to rally 20 percent — according to a bulletproof indicator produced by Bank of America Merrill Lynch.

Sentiment is commonly used as a contrarian indicator, meaning one is thought to be well-served by doing the opposite of what most investors are inclined to do. According to this line of thinking, when there's a preponderance of bulls, there are fewer marginal buyers, and bad news is more surprising than it would normally be. Conversely, when many investors are bearish, there are more potential buyers than sellers, meaning stocks could be set to rise.

The strategists at Bank of America Merrill Lynch have crystallized this insight into an indicator, known as the "sell side consensus indicator," which uses the month-end recommended equity weightings of Wall Street strategists to forecast the 12-month returns of the S&P 500.

At this point, the indicator it at its lowest level in more than three years, meaning that it "remains firmly in 'Buy' territory after triggering a contrarian Buy signal in April," according to a Thursday report produced by BofAML's equity and quant strategy team. (Incidentally, since the May 2 report stating that the indicator slipped into buy territory, the S&P is up nearly 6 percent.)


The report goes on to state that when the indicator, which dates to 1985, "has been this low or lower, total returns over the subsequent 12 months have been positive 100 percent of the time, with median 12-month returns of +27 percent."

At this point, the indicator "implies a 12-month price return of 20 percent, and a 12-month value of 2,604"; for a 22 percent return after the S&P's 2 percent dividend yield is added in

To be sure, this is not BofAML's S&P 500 target. Indeed, the slightly ironic subtext to the report is that BofAML's own head strategist, Savita Subramanian, has a year-end price target of 2,000, which implies a big market drop into the end of the year.

She is concerned about the market's valuation and about high expectations for growth, and while Subramanian acknowledges the sell side indicator's sign, she also says that real-world positioning has become more bullish.

So should you follow the strategists, or sprint in the opposite direction?

It depends on how contrarian you feel, but one thing is for sure: stocks have tended to rise over time, and maintaining a substantial position in stocks over long time frames has proven a winning strategy no matter what Wall Street's prognosticators say.

Indeed, a December BofAML report finds it "worth noting that Wall Street recommended underweighting equities through the entire bull market of the 1980s and the 1990s," with an allocation to stocks below 55 percent being the dominant recommendation among strategists during that time period.


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Brian Sullivan

Brian Sullivan is co-anchor of CNBC's "Power Lunch" (M-F,1PM-3PM ET), one of the network's longest running programs, as well as the host of the daily investing program "Trading Nation." He is also a frequent guest on MSNBC's "Morning Joe" and other NBC properties.

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