Main Street and Wall Street are historically divided over the economic recovery. One Wall Street chief strategist explains why that’s actually a positive for stocks.

• The historically wide gap between Main Street and Wall Street sentiments suggests stocks are poised for a massive run-up, James Paulsen, chief investment strategist at The Leuthold Group, said Friday.
• Bloomberg's gauge of consumer comfort sits higher than 76% of its readings since 1987. A popular index of investor sentiments is currently lower than 97% of its readings in the same period.
• The S&P 500's return has averaged 20.6% in instances of the same scenario dating back to 1988, Paulsen said.
• The index only returns an average 8.1% when Wall Street and Main Street sentiments are above their averages, he added.
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Wall Street and Main Street sentiments are in a rare divide that can send stocks soaring if precedent holds.

The gap in performance between the stock market and the greater economy has come to encapsulate the unprecedented dynamics fueled by the coronavirus pandemic. While the US suffered its worst recession since World War II, the stock market erased its virus-induced losses and surged to record highs in a matter of months. Accordingly, investor sentiments diverged significantly from those still struggling through the pandemic.

Yet sentiment gauges show a different pattern relative to their historical trends, James Paulsen, chief investment strategist at The Leuthold Group, said in a Friday note. Bloomberg's gauge of consumer comfort — a popular proxy for Main Street's economic outlook — is currently higher than 76% of readings made since 1987.

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Conversely, the American Association of Individual Investors' index of market participants' bullishness is lower than 97% of all readings in the same period. While the market rebounded faster than the economy, investors remain plenty concerned.

Yet similar instances in the past gave way to outsized market gains, according to the strategist. The S&P 500's average forward one-week return stands at 20.6% when Wall Street sentiments are below average and Main Street outlooks exceed their average, Paulsen said. When both sides of the economy are more bullish than average, returns only average 8.1%.

"When 'everyone' feels good, it is often time for stock investors to turn cautious," the strategist said.

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Today's environment is also the rarest, with a frequency of just 19% since 1988. Instances of both Main Street and Wall Street sentiments trending below average have a 31% frequency, Paulsen said.

Oddly, the ideal sentiment backdrop has grown increasingly prevalent since 2015. From then on, the Main Street-positive, Wall Street-negative scenario has characterized market conditions 56% of the time.

Paulsen said he believes the Great Recession sparked the shift. Main Street and Wall Street were both largely bearish from 2008 to 2014. Yet while Main Street sentiments recovered to "mainly constructive" levels, Wall Street's median sentiment has remained at the lows seen just after 2008. The disconnect widened throughout the 2010s and possibly drove stocks' rally from 2016 to 2018, Paulsen said.

Equities still need to contend with election uncertainties, rising coronavirus cases, a stimulus stalemate, and a slowing pace of economic recovery before investors are in the clear. Yet the mix of Wall-Street pessimism and Main-Street optimism suggests investors could miss out on hefty returns should they sit out the next few months, Paulsen wrote.

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