Another stock market buy signal flashes as investors flee to 'extreme bearish' positioning

• The stock market just flashed a contrarian buy signal as investors turn extremely bearish.
• Bank of America highlighted that its proprietary Bull and Bear Indicator entered "Buy" territory this week.
• The stock market has historically seen a median gain of 5% after this buy indicator flashed.

Another buy signal just flashed for the stock market as investor positioning turns overly bearish towards equities, according to a Thursday note from Bank of America.

The bank highlighted that its Bull and Bear Indicator just entered "extreme bearish" territory, which represents a contrarian buy signal for the stock market. The last time this signal flashed was in May 2022. This signal flashed just a few days after another contrarian buy signal flashed in the form of investors boosting their cash allocation levels.

The BofA Bull and Bear indicator is contrarian in the sense that it flashes a "buy" signal when stock market conditions are extremely bearish, and it flashes a "sell" signal when stock market conditions are extremely bullish.

Factors that drove the signal into extremely bearish territory over the past week includes fund outflows from emerging market debt, high yield bonds, and global stocks, as well as a surge in cash allocations among professional investors on Wall Street.

"Positioning [is] now 'extreme bearish' ...triggers contrarian 'buy signal' for risk assets," Bank of America investment strategist Michael Hartnett said.

This contrarian indicator has been pretty reliable over time. Since 2002, there have been 20 buy signal occurrences, with the median three-month return after the signal flashed being 5.4% for US stocks and 7.6% for global stocks, according to the note.

Bearish sentiment has grown in recent weeks as bond yields surged and stock prices fell. The CNN Fear and Greed index has been in "Fear" territory since the start of the month, and the AAII Investor Sentiment survey has seen bearish responses above its historical average over the past four weeks.

"Investors [are] sufficiently bearish for 10-year yield at 5% ceiling," Hartnett said, adding that the S&P 500's key support level of 4,200 should hold in the short-term.

And if that level doesn't hold, its a sign that economic conditions are deteriorating.

"If S&P 500 [support level] 4,200 can't hold with this level of bearishness then there may be imminent risks of [a] credit event/hard landing," Hartnett said.