Unprecedented Bearish Sentiment Signals Potential Market Recovery

Since 1987, the American Association of Individual Investors (AAII) has conducted weekly surveys to measure investor sentiment. Participants respond to one key question: Do you think the stock market will increase (bullish), remain the same (neutral), or decline (bearish) over the next six months? The results are released every Thursday morning.

As of March 27, bearish sentiment has exceeded 50% for five consecutive weeks. Such a prolonged period of pessimism is rare; in fact, this has only occurred once since the Great Recession, which ended in June 2009.

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The S&P 500 (SNPINDEX: ^GSPC), a leading benchmark for the U.S. stock market, is currently 9% below its all-time high. Historically, investor sentiment serves as a contrarian indicator, as extreme pessimism often precedes market gains. Indeed, historical trends suggest that the S&P 500 could see significant increases in the coming year.

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Examining the Current Market Sentiment

Current investor sentiment is notably pessimistic, with a bearish reading of 52.2% in the latest AAII survey, marking five straight weeks above the 50% threshold. The only other time this level of pessimism persisted since the Great Recession was late in 2022. At that time, fears of recession were fueled by high inflation and rapidly rising interest rates.

Interestingly, the bull market began around that same time. Following the fifth consecutive week of bearish sentiment above 50% in 2022, the S&P 500 surged 15% over the next year. This dynamic highlights the contrarian relationship between market sentiment and performance.

During the past 15 years, bearish sentiment has topped 50% only 33 times, representing about 4% of that period. Remarkably, the S&P 500 averaged a return of 22% in the twelve months following these instances. While past performance does not guarantee future results, this historical data can help inform current decisions.

Specifically, on March 27, the S&P 500 closed at 5,693, the same day the AAII survey results were released. If historical averages hold true, the benchmark index could reach 6,945 over the next year, indicating a potential 22% increase from its current level of 5,580.

Tariffs and Market Implications

The market has faced downward pressure from economic uncertainty stemming from tariffs instituted by the Trump administration. Recently, JPMorgan Chase raised its forecast for recession probability from 30% to 40% to reflect this uncertainty. Chief global economist Bruce Kasman wrote, “We see a materially higher risk of a global recession due to U.S. trade policy.”

Tariffs during the first Trump presidency contributed to a 19.8% decline in the S&P 500 between September and December 2018. They increased the average tax on U.S. imports to approximately 3%. In contrast, recent tariffs could raise this average to 10%, a level not seen since the 1940s. Should the administration pursue a 20% universal tariff, it would represent the highest levy on imports since the 1930s.

The takeaway for investors is clear: if a modest increase in tariff rates resulted in a 19.8% drop in the S&P 500 in 2018, a more substantial increase could have an even larger impact today. This possibility helps explain the current heightened bearish sentiment.

Investors should prepare for continued market volatility until clearer signals about U.S. trade policy emerge. The S&P 500 may face further declines in the near future. However, it’s important to remember that market downturns have historically offered excellent buying opportunities.

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Note: JPMorgan Chase is an advertising partner of Motley Fool Money. Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends JPMorgan Chase. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Nasdaq, Inc.