The Most Reliable Contrarian Buy Signal Just Triggered

Lou Basenese

Thursday, April 14, 2022

On any given day, everyone knows stock prices can either go up or down.

It’s what stocks do over longer periods of time that matters. And today, I’m here to tell you that stocks are headed higher over the next six months!

I’m so confident, in fact, that I’ll donate $1,000 to charity if the S&P 500 index isn’t higher on October 10, 2022 than it is today.

Have I lost my mind? Heck, no!

I’m simply responding to the latest reading of the most reliable contrarian indicator in the world.

It just hit a 20-year low. And every time it drops anywhere close to this level – you guessed it – stocks trade (much) higher over the next six months.

Here are all the details, and the best way to play it.

That is, if you have the intestinal fortitude to not only think like a true contrarian… but to act like one.

Bulls Pull a Houdini

With inflation soaring, war in the Ukraine, and a seemingly never-ending pandemic, it’s easy to understand why so few individual investors are bullish on stocks. But this is getting too extreme.

The latest survey from the American Association of Individual Investors (AAII) reveals that only 15.8% of investors are bullish right now. That’s the lowest weekly reading since September 4, 1992.

Whatever you do, don’t join them!

Why? Because whenever bullish sentiment drops below 20%, the thing to do is resist bailing on stocks and instead back up the truck to buy them because they always rally.

The data doesn’t lie…

  • Since 1987, bullish sentiment has dipped below 20% on 33 separate occasions. (The last two sub 20% readings came this week and on February 16 of this year, making them too recent to include in our analysis here.)
  • And if we go out six months from the initial reading, 31 out of 31 times, the S&P 500 Index has traded higher.

Here’s the key: stocks didn’t end up marginally higher, they ended up significantly higher.

More specifically, the average return checks in at 12.7%.

That’s a full two percentage points more than the long-term average return of the S&P 500 since its inception.

Calling Your Shots

I’m willing to bet this indicator’s perfect streak will remain intact once we get six months out from the latest two readings. Especially since the lower sentiment goes, the higher stocks tend to trade over the longer term…

I dug into the data even more this morning and found that the average return for the S&P 500 jumps to 14% any time AAII bullish sentiment drops to 16% or lower. (It’s happened 12 times since July 1988.)

What’s more, if we’re willing to accept an almost perfect track record, we can earn even higher returns.

How? By buying small-cap stocks instead of large-cap ones, represented by the S&P 500.

You see, when bullish sentiment retreats, small stocks soar in the ensuing months, too. By an average of 17.7%.

And while it doesn’t happen 100% of the time, it’s damn near close at 93.5% or 29 out of 31 times.

Once again, if we look at extreme low readings of 16% or less, the outperformance is even more pronounced.

Small-cap stocks, represented by the Russell 2000 index, rallied an average of 24%. That’s 10 full percentage points more than large caps. In a single year.

Bottom line: You’re not going to find a more accurate contrarian indicator in the market. So don’t ignore it. Instead, be quick to follow it, especially into today’s Trend Trader Pro “Trade of the Week.” As you’ll see, it allows us to potentially earn three times the historical average profit for small caps.

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Ahead of the tape,
Lou Basenese
Lou Basenese

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