‘Buy’ signal triggered by extreme bearishness

It finally happened: investors are so bearish that a contrarian “buy” signal has been triggered. The Bull and Bear indicator developed by researchers at Bank of America Merrill Lynch is finally indicating Buy, one year after climbing so high that it triggered a Sell signal.

We all know how the year between these two signals went. Investors were relatively optimistic in the first quarter of 2018, and after that markets witnessed a slow-motion train wreck.

Since the Bull and Bear indicator triggered its Sell signal, the global equity markets lost $19.9 trillion in market capitalisation peak to trough, almost as much as the entire US GDP, according to research carried out by Bank of America Merrill Lynch.

Global banks’ stocks have seen their prices fall back to the lows of 2008. Out of 2767 big companies in the US and the world, 2055 are in a bear market. A bear market is usually defined as a fall in a security’s price of more than 20% from its peak.

The outflows accelerated in the last weeks of 2018 to a frightening speed. There were record outflows from equities in the last six weeks of the year, of $84 billion, and from corporate bonds, of $34 billion, compared with record government bond inflows of $24 billion as investors sought safe havens.

The Bull and Bear indicator fell to 1.8 — a reading of “extreme bear” like anything below the 2 level.

Bull and Bear indicator showing the Buy signal

Source: Bank of America Merrill Lynch Investment Strategy

Looking at the indicator’s components, only one – hedge fund positioning – is bullish. Two are neutral – credit market technicals and equity flows – one (long-only positioning) is bearish and the remaining two, equity market breadth and bond flows, are very bearish.

One word of caution about this indicator: its actual hit rate when it comes to “Buy” signals (the “extreme bear”) is 60%, and it has only been around for six years or so.

Besides, there are other indications out there that perhaps this isn’t the big capitulation that everybody had been expecting: for one, profit expectations are still too high. The contrarian Buy signal may have been triggered, but this doesn’t necessarily mean the markets will shoot up.