A Stock Market Indicator Seen Just Once Since the Great Recession Is Flashing. History Says This Will Happen Next.

Since 1987, the American Association of Individual Investors (AAII) has conducted weekly surveys to measure investor sentiment. Participants answer a simple question: Do you think stock market over the next six months will increase (bullish), stay the same (neutral), or decline (bearish)? Results are published every Thursday morning.

As of March 27, bearish sentiment has topped 50% in five consecutive weeks. A reading that high in a single week is uncommon, but for bearish sentiment to exceed 50% for five straight weeks is virtually unheard of. In fact, it has only happened once since the Great Recession, ended in June 2009.

The S&P 500 (^GSPC 0.38%), the best benchmark for the U.S. stock market, is currently 9% below its record high. But sentiment is often viewed as a contrarian indicator, because pessimism often precedes gains in the market. Indeed, history says the S&P 500 could rocket higher in the coming year.

History says the stock market could soar during the next year

Investors are unusually pessimistic. Bearish sentiment was 52.2% in the most recent AAII survey, marking the fifth consecutive weekly reading above 50%. The only other time investors have been so persistently bearish since the Great Recession was late 2022, when brutal inflation and rapidly rising interest rates led to recession fears.

However, the current bull market actually started around that time, and the S&P 500 advanced 15% during the 12-month period following the fifth straight bearish sentiment reading above 50% in 2022. That perfectly captures the contrarian relationship that often exists between market sentiment and performance.

Another interesting fact is that bearish sentiment has only topped 50% in 33 weeks during the last 15 years, or approximately 4% of the time. The S&P 500 returned an average of 22% in the 12 months following those incidents. Past performance is never a guarantee of future results, but we can still apply that information to the present situation to make an educated guess.

Specifically, the S&P 500 closed at 5,693 on March 27, the day the latest AAII survey results were published. The benchmark index will advance 22% to 6,945 during the next 12 months if its performance matches the historical average. That implies 24% upside from its current level of 5,580.

Tariffs have dragged the stock market down, and the situation could get much worse

Economic uncertainty related to tariffs imposed by the Trump administration has dragged the market lower. JPMorgan Chase recently increased its recession probability forecast to 40%, up from 30%, to account for that uncertainty. “We see a materially higher risk of a global recession due to U.S. trade policy,” wrote chief global economist Bruce Kasman.

Tariffs during the first Trump presidency contributed to the 19.8% drop in the S&P 500 between September 2018 and December 2018. Importantly, those tariffs raised the average tax on U.S. imports to about 3%. But recent tariffs will raise the average tax on U.S. imports to 10%, a level not seen since the 1940s. And if Trump forges ahead with a 20% universal tariff, that would be the most severe tax on U.S. imports since the 1930s.

Here is the takeaway for investors: If the relatively small increase in the average tariff rate caused the S&P 500 to tumble 19.8% in 2018, then the much steeper increase outlined by the president this time around could have a correspondingly larger impact. That possibility may explain why bearish sentiment has been so pronounced recently.

Unfortunately, the market is likely to remain volatile until it has more clarity on U.S. trade policy. That means the S&P 500 may continue falling in the coming weeks and months. But the silver lining for investors is that drawdowns have always been great buying opportunities in hindsight.