Mom-and-Pop Pessimism on Stocks Historically a Good Sign

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Main Street bulls are fast becoming an endangered species.

Despite the fact that the broad U.S. stock market is up 8.4 percent in 2012, only 22 percent of mom-and-pop investors said they were bullish, the American Association of Individual Investors found in its latest weekly poll.

That's the lowest sentiment reading since summer 2010, when markets were careening lower in the face of the first post-recession global growth scare and the emergence of Europe's debt crisis.

But to drive home just how pessimistic Main Street investors have become in the face of a weak U.S. economy, slowing growth in China and continued uncertainty about Europe's financial crisis, consider that:

• Bullishness now is more depressed than in the fall of 2008, when Wall Street titan Lehman Bros. declared bankruptcy, thrusting the financial crisis into a more dangerous phase.

• The percentage of bulls today is barely above the 18.9 percent on March 5, 2009, just four days before the bottom of the worst stock slide since the Great Depression. That, of course, was a good time to buy.

Growing disenchantment with stocks is not surprising, market experts say, given a decade of low returns, a loss of faith in Wall Street and fears that another big drop is coming. "There is always something," says Paul Hickey of Bespoke Investment Group. "It zaps confidence."

Indeed, a pair of 50 percent stock market plunges since 2000 has eroded confidence. The May 2010 "flash crash" — when the Dow Jones industrials fell almost 1,000 points in seconds due to computer glitches — added to the angst.

The botched initial public offering of social media darling Facebook two months ago also reinforced the idea that the stock market is a place to be wary of. Add in the recent LIBOR interest-rigging scandal and JPMorgan Chase's almost $6 billion loss due to risky trades gone bad and you end up with individual investors in a negative state of mind.

"The bottom line is the majority of the retail investing crowd is frustrated and has been scared out of this market. It seems like they have been burned one too many times and feel like the market is a rigged game," said Ryan Detrick, senior technical strategist at Schaeffer's Investment Research.

But all the negativity may turn out to be a positive: History shows that super-low sentiment readings tend to act as a contrarian signal. In other words, when everyone is worried, stocks tend to rally.

In fact, according to Bespoke, going back to November 2009, U.S. stocks have posted average gains of 5 percent — with gains 100 percent of the time — in the month after AAII's sentiment poll showed bullish sentiment readings below 25 percent.