Contrarian buy signals echo last year’s bear-market low

11/15/2023 — The S&P 500® Index suffered a minor pullback between July and October, dropping below its 40-week moving average and raising concern among bullish investors. During this period, several important market indicators similarly were in play to last year’s market drawdown, culminating in what many market participants believe to be the bear-market low on October 12, 2022.

In 2022, as the S&P 500 approached the bear market low, several contrarian market signals flashed red, including dour investor sentiment, oversold indexes, positive breadth divergences, and tight financial conditions. The near-universal pessimism that coincided with the bear market bottom might have been a contrarian buy signal. Interestingly, similar market indicators flashed red during the July-October 2023 drawdown. Since then, the S&P 500 Index has rallied over 6% as of this writing.

It’s reasonable to assume that the conditions during the 2022 drawdown echoed those during the July-October 2023 drawdown. First, there were clear signs of panic from individual investors, as depressed sentiment and positioning indicators, as represented by the AAII bull-bear spread, showed that investors were likely too bearish. Second, the NAAIM Exposure Index (a measure of sentiment and positioning) tumbled from its July high of 101 toward a nearly oversold, contrarian bullish level of 24 on October 25.

Third, Bank of America’s Bull & Bear Indicator recently hit its lowest point since last November—an extreme bearish level that could be read as a contrarian buy signal. Fourth, tighter financial conditions, recession fears, and the lagged effects of Fed rate hikes continued to weigh on investors—a climate that also impacted investors in the 2022 downturn. It’s important to mention that the sharp decline in the 10-year Treasury yield in October played a crucial role in the stock market’s recovery, helping the S&P 500 notch eight consecutive days of gains from October 30 through November 8.

November through December is historically the best two-month period for equities so that a year-end rally might be possible. However, even repeatable patterns in market indicators should be taken with a grain of salt. It remains vital for investors to focus on the long term and maintain a diversified portfolio that can weather short-term fluctuations in the financial markets.