Bank of America Merrill Lynch: Key indicators show that U.S. stocks are far from extreme "bubble" levels
Bank of America’s “sell-side indicator” rose slightly to 55.7% in October, remaining in the “neutral” range, still away from triggering a “sell” signal at 57.8%. Historically, when the market peaks, the reading of this indicator typically exceeds 59%. According to the historical model of this indicator, the current level of 55.7% suggests a potential price return of 13% for the S&P 500 index over the next 12 months
With the S&P 500 Index recording its longest consecutive six-month rise since 2021, discussions about "irrational exuberance" in the market have resurfaced.
However, according to a report released by Bank of America Merrill Lynch on November 2, a key Wall Street sentiment indicator—the "Sell Side Indicator" (SSI)—is currently far from reaching the extreme "bubble" level that would trigger a "sell" signal.
The "Sell Side Indicator" is a contrarian sentiment signal, meaning that when Wall Street strategists are overall extremely pessimistic, it often predicts a rise in the stock market, and vice versa. Data shows that the indicator slightly increased from 55.5% to 55.7% in October.
The report points out that the current reading of 55.7% remains in the "neutral" zone. While it is far from the threshold that triggers a "buy" signal (51.3%), it is still 2.1 percentage points away from the threshold that triggers a "sell" signal (57.8%).
More importantly, Bank of America emphasizes that historically, when the market peaks, the reading of this indicator typically exceeds 59%. This means that although there are fewer bears, market sentiment has not yet reached an irrational level of enthusiasm.
"Sell Side Indicator" suggests 13% upside potential in the next year
The "Sell Side Indicator" is not only a sentiment thermometer but also a predictive tool. Bank of America's analysis shows that this indicator's ability to predict the S&P 500's returns over the next 12 months (with an R² value of 25%) significantly outperforms other single-factor models such as price-to-earnings ratios and dividend yields.
Based on its historical data model, the report clearly states that the current SSI level of 55.7% implies a healthy price return of 13% for the S&P 500 Index over the next 12 months. However, this prediction is only one of five factors that Bank of America considers when setting its target price for the S&P 500.
Looking back at historical performance, the contrarian predictive ability of this indicator is quite clear:
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When the indicator is in the "buy" zone, the average total return of the S&P 500 over the subsequent 12 months is 20.5%.
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When the indicator is in the "sell" zone, the average total return over the subsequent 12 months plummets to 2.7%.
The current "neutral" reading suggests that the market is neither extremely undervalued nor extremely overvalued.
Strong fundamentals, but the market has already priced in
The report also analyzes the fundamentals of the market. Among the companies that have released their financial reports, 63% achieved both earnings per share (EPS) and revenue that exceeded expectations, the highest proportion since 2021, indicating strong corporate fundamentals.
However, the market's reaction reveals another side. The report shows that companies that exceeded expectations in both metrics saw their stock prices average only 0.9 percentage points above the market the following day, below the historical average of 1.4 percentage points. Meanwhile, companies that did not meet expectations faced severe penalties, with their stock prices averaging 7.2 percentage points below the market, nearly three times the usual decline.
This phenomenon strongly indicates that a large amount of "good news" has already been digested and priced in by the market before the earnings season begins. Investors have high expectations for the future, which means that any disappointing news could trigger severe sell-offs.
The report concludes with a reminder that, although liquidity remains abundant, investors should be wary of any reversal in liquidity channels, especially when a Federal Reserve rate-cutting cycle coincides with credit tightening, as this is typically the worst phase for the stock market.
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