Bearish investors are chasing the rally in U.S. stocks. Here’s what that means for the market.

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Amateur and professional investors alike are finally warming to the idea that U.S. stocks can continue to climb higher during the months ahead.

All it took, it seems, was a rise of more than 20% off the S&P 500’s October lows, the threshold need to end its longest stint in bear-market territory since 1948.

Over the past few days, stock-market strategists have been discussing a handful of popular sentiment surveys all showing the same thing: that individual investors, market newsletter-writing gurus and professional money managers are growing increasingly optimistic about the market’s prospects.

The most recent reading from the American Association of Individual Investors Sentiment Survey showed that as of June 7, 44.5% of respondents said they expected U.S. stocks to be higher six months from now, while 24.3% remained bearish (the balance said they had a “neutral” view).

That was the first time since November 2021 where bullish sentiment exceeded bearish sentiment by more than 20%, the data show. It also was the first time since February that the share of individual investor respondents identifying as bullish eclipsed the long-term average of 37.5%.

And hasn’t only been a shift in tone from individuals: Professional investment managers recently reported a similar change of heart. The National Association of Active Investment Managers’ Index showed average exposure to the U.S. equity market surged to just over 90% during the week ended June 7, up from 53.9 during the prior reading. That also marked the highest reported exposure since November 2021.

Finally, Investors Intelligence Advisors’ Sentiment Report also showed bullish sentiment among professional advisers has reached its highest level since U.S. stocks peaked in January 2022.

Analysts’ interpretations of these developments vary. Some see the shift as a sign that investors will continue to chase the rally in stocks higher, perhaps by building positions in small- and medium-cap stocks, which have been reversing a streak of lackluster performance.

“I don’t think we’re at an extreme level of bullishness,” said Dr. Ed Yardeni, the president of Yardeni Research, during a phone interview with MarketWatch. “We’re at a point where both institutional and individual investors are turning more optimistic.”

Others see a potential turning point, citing examples from the past 18 months where bear-market rallies gave way to fresh lows, just as sentiment was starting to improve.

“During this bear market, extreme greed and elevated exposure has acted as the ‘canary in the coal mine’…this combination has preceded all meaningful declines,” said Twitter user Tom the Trader, who shared a chart showing near-term highs in bullish sentiment coinciding with key market turning points in 2022 and 2023.

As the chart above shows, CNN’s Fear and Greed Index lurched back into “extreme greed” territory for the first time since early February last week. Last time it was at these levels, it coincided with a short-term market top that had held until late last month.

To be sure, the fear and greed index isn’t a survey gauging investor sentiment. Instead, it incorporates an S&P 500 moving average, the put-to-call ratio on S&P 500 options, the level of the Cboe Volatility Index relative demand for bonds compared with stocks, and other market-based inputs.

The shift in sentiment represents a dramatic change from early in 2023.

Back then, both Wall Street professionals and small-time investors were skeptical about the prospects for a sustained rally, even after the market hit the “January trifecta” and the Nasdaq recorded its best start to a year since the dot-com crash.

Sentiment data suggest that many investors dismissed the market’s performance in January as a “dead-cat bounce,” Wall Street jargon for a doomed reprieve in the midst of a bear market.

And when the market started to soften again in February, both sentiment and reported positioning quickly slumped.

Since then, U.S. stocks have continued to trudge higher despite the collapse of several midsize banks, sticky inflation and more interest-rate hikes from the Federal Reserve.

One key factor boosting stocks, according to Yardeni, is that a recession that the bond-market and consumer-sentiment data were signaling for the better part of a year has yet to materialize.

As a result, Wall Street analysts’ expectations for corporate earnings for the balance of 2023 and early 2024 have started to brighten. Since stock values are typically determined in part by earnings expectations, this means that the relative valuation for stocks compared with bonds is growing increasingly attractive, even as the market continues to climb.

Yardeni and Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, both said on Monday that improving earnings expectations appear to be instrumental in changing investors’ minds.

The rate of upward earnings revisions for S&P 500 companies improved to 57% in early June, according to a report published by Calvasina and her team that was shared with MarketWatch.

“Like earnings revisions trends, investor sentiment is also midway through a healing process,” she added in the note.

Better earnings and the absence of a punishing recession portend could more gains for stocks ahead, especially small-caps represented by the Russell 2000 index and midcaps represented by the S&P 400 midcap index Both have outshone the S&P 500, Nasdaq Composite and Dow Jones Industrial Average so far in June.

The result, according to Yardeni, is that investors will likely continue to chase the market higher as the rally “broadens out,” meaning megacap technology stocks that have driven much of the Nasdaq’s outperformance so far this year will receive more help from corners of the market that had previously lagged.

“We’re seeing this as a broadening of the bull market into small- and midcap stocks,” said Yardeni, who has been bullish on the market since shortly after the S&P 500 logged its 2022 closing low of 3,577.03 on Oct. 12.

U.S. stocks continued to advance on Monday, building on the Nasdaq Composite’s seven-week winning streak, its longest since 2019, according to FactSet data.

The S&P 500 gained 0.9% on Monday, bringing its advance since the start of June to 3.8%. The Nasdaq Composite rose by 1.5% on Monday, bringing its month-to-date gain to 4.1%. The Dow Jones Industrial Average added 189.55 points, or 0.6%, while trailing both indexes for the month.

The Russell 2000 rose 0.4%, bringing its month-to-date gain to 7.1%, according to FactSet data.

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