Stock market contrarians believe that going against the herd is a formula for scoring big profits, and that high levels of investor pessimism are a bullish signal. Remarkably, that's the case even as the S&P 500 Index (SPY) has risen to record levels, reaching yet another record high this week. “Unlike any in at least the last 50 years, the contemporary bull market has coexisted with a tall and persistent Wall of Worry,” Jim Paulsen, chief investment strategist at The Leuthold Group, wrote in a recent note to clients

“The Worry Gauge suggests most investors already expect, and are prepared for, a difficult future," Paulsen added. The Worry Gauge, developed by The Leuthold Group, measures investor confidence by comparing the price of gold relative to other commodities and the price of small cap stocks to large caps.

The table below shows that stocks have risen sharply when the Worry Gauge has been near its highest levels, based on history from 1970 to now.

What Jim Paulsen's Worry Gauge Indicates

  • Gauge has been in top two quintiles (high worry) during 75% of current bull market
  • Top quintile throughout last 4 years, except at market peak in Sept. 2018
  • When in top quintile, S&P 500 gains 4.33% on average in next 3 months
  • When in top quintile, S&P 500 falls only 25% of the time in next 3 months

Source: CNBC

Significance For Investors

The Worry Gauge is a behavioral index. Paulsen first divides the price of gold by the Goldman Sachs Commodity Index. If this figure rises, it's a sign that nervous investors probably are fleeing to gold as a safe haven. He then divides the value of the small cap Russell 2000 Index by the large cap S&P 500 Index. The higher this figure is, the more confident and aggressive investors appear to be. The first figure divided by the second one is the Worry Gauge measure. The higher it is, the more worry there is in the market, according to Paulsen.

There's plenty of worry out there. Among Wall Street firms, Morgan Stanley has been the leading worrier, forecasting falling corporate earnings, declining GDP growth, and sinking stocks, with the S&P 500 dropping to 2,750 by year-end 2019, 6.1% below the April 25 open. Most recently, Morgan Stanley warned about the demise of growth stocks, the bull market leaders.

Both the S&P 500 and the Nasdaq Composite hit new all-time record closing highs on April 23, but without much excitement. “The sentiment is typically not bullish,” Scott Redler, a trader and chief strategic officer at broker-dealer firm T3 Live, told CNBC. “Everyone is worried about ... trade wars, while passive money comes in and the market marches higher," he added.

“We’ve essentially just gone back to September. People look at this 17% year-to-date move and say it seems like an unsustainable trend,” said Jack Ablin, chief investment officer (CIO) of Cresset Wealth Advisors, per CNBC. “This is just taking back the correction. Putting it in that context, I would say I’m not as worried about the market as a lot of people. In the earnings reports, there were some blockbuster surprises,” he added.

Looking Ahead

“I think it’s slow and steady. My guess is we’re not going to make a fortune here, but it doesn’t sound like the bottom is going to fall out," Ablin says. “We tend to advance by an average of 10% before falling into another decline of 5% or more,” Sam Stovall, chief investment strategist at research firm CFRA, told CNBC. Though Stovall forecasts stocks will see a correction starting next month, he sees the bull market returning to its upward trajectory by the end of this year.