You've just gotta love Wall Street analysts and their favorite indicators.
Today, Bank of America/Merrill Lynch (BAML) published a research note examining current equity market sentiment. The note focuses on what BAML calls the Sell Side Indicator, a measure used to judge the bullishness or bearishness of stocks, broadly speaking. The theory behind the indicator states that when investor sentiment is very bullish it is a sell signal, and when sentiment is very bearish it is a buy signal.
Today's research note said the Sell Side Indicator has hit 52.9, up from 52.8 most recently, marking its highest level in 16 months. The note argues that when the indicator has fallen this low or lower, total returns over the next 12 months have been positive 94% of the time. It also asserts that improving sentiment could be a step toward the kind of market euphoria that can typically arrive at the end of a bull market. BAML's indicator has been tracking sentiment since 1985. For reference, the indicator hit 71 in 2000 and 44 in 2012.
This logic makes your head hurt. The chart's purported signal based on bullishness or bearishness make absolutely no sense. Yes, there is most certainly a relationship between market sentiment and market peaks and troughs. But the accuracy of the Sell Side Indicator chart below seems suspect, at best.
Source: Bank of America/Merrill Lynch Global Research US Equity & Quant Strategy Note: Buy and Sell signals are based on rolling 15-year +/- 1 standard deviation from the rolling 15-year mean. A reading above the red line indicates a sell signal and a reading below the green line indicates a buy signal.
The timing of the chart, which should have flashed a big sell signal at the start of 1998, missed out on the entire run-up in equity prices through 2000. In hindsight, it's clear you might have been better off not investing after 1998, but hindsight only works retroactively.
The sell signal stayed in place until 2004, which would have led an investor to miss the bottom of the market in 2003 and the run up through 2007. The signal remained on the border of neutral and sell area for most of the time until 2008. Additionally, the sell signal in the 2007-2008 period was not nearly as strong as the one seen in 2000.
Meanwhile, for most of the time from 2008 until 2012, the index was in neutral territory, when the equity market was collapsing in 2008 and 2009 and then recovering from the effects of quantitative easing. Then the buy signal was at its strongest in 2012, well after the market had already regained much of its financial crisis losses. The indicator also suggests that investor sentiment has been in an overall downtrend since 2000.
This sort of analysis is nothing but market timing. There is an excellent alternative: invest in the stock market for the long term, or identify a business you like and believe will grow over time. BAML notes that the Sell Side Indicator analysis is a part of the model they use to calculate their overall S&P 500 price target. Earlier today, the firm raised this very price target on the S&P 500 to 2450 from 2300, even as the index itself is testing 2396. Yep, one has to love it.