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Why BofA Says That Analysts Are More Bearish Than They’ve Been In 27 Years
Since we posted about how BofA’s sell-side sentiment indicator is currently flashing the biggest bullish signal for stocks they’ve ever seen, we’ve received a few questions about the math behind the indicator.
Here is BofA head of quant and equity strategy Savita Subramanian’s explanation of how the indicator is calculated:
The Sell Side Indicator is based on our survey of the Wall Street Strategists that submit their asset allocation recommendations to us or to Bloomberg (currently, there are nine). For this indicator, we use the simple average of the recommended equity weighting for each strategist as of the last business day of each month. The thresholds for the Buy and Sell readings are rolling 15-year +/- 1 standard deviations from the rolling 15-year mean (previously, we had used cumulative standard deviations and means).
We have found, when adding a little math, that Wall Street’s consensus equity allocation has historically been a reliable contrary indicator. In other words, it has been a bullish signal when Wall Street was extremely bearish, and vice versa. The Sell Side Indicator does not catch every rally or decline in the stock market, but as you can see in Chart 2, the indicator has historically had some predictive capability with respect to subsequent 12-month S&P 500 total returns. Although the r-squared of 27% might sound low, it is significantly higher than similar statistics for typical variables used in stock market timing models (Table 1). In particular, note that such heralded indicators such as the “Fed Model” and money growth have relatively little predictive value.
Here is the chart that shows the correlation between the indicator and the S&P 500′s subsequent 12-month return:
And here is a table provided by BofA Merrill Lynch comparing the sell-side indicator’s predictive power against a few other familiar strategies: