Fundamentally: Pessimism Can Be the Stock Market’s Best Friend

SINCE the market ran into serious trouble during the summer, the Standard Poor’s 500-stock index has clawed its way back to the 1,200 level on four separate occasions. On the first three runs, the rallies quickly lost steam amid fresh sets of worries about the global economy.

No wonder that investors have shown little confidence in the staying power of the latest rebound, which since Oct. 3 has lifted stock prices by 13 percent, leaving the S. P. at 1,238. Last week, the Investors Intelligence adviser survey, a widely followed gauge that tracks the opinions of more than 100 independent investment newsletters, showed that bears continued to outnumber bulls even though the index had climbed almost half the way back.

But sentiment can be a funny thing. The best thing that Wall Street may have going for it right now is that so many investors are pessimistic. That’s because the mood in the market is often regarded as a contrarian indicator of future activity.

In late April, for example, the number of bullish newsletter advisers outnumbered bears by a ratio of three to one — with 54.3 percent of advisers expressing optimism at the time and 18.5 percent being bearish. That sense of hope was registered just as the market peaked and started its worst slide since the financial crisis, dropping 19.4 percent by early October in what some strategists have considered to be a bear market. (In recent years, a bear market has often been defined as a 20 percent drop in prices, based on daily closing values.)

Conversely, in the logic of contrarian thinking, negativity can be a very good thing. “When you see high levels of pessimism, it can be a sign of a market bottom and signal that there’s lower risk to buy,” said John Gray, co-editor of Investors Intelligence.

Sentiment indicators for consumers, on the other hand, are often regarded as a good way to capture the emotional state of households — yet they’re often wrong when it comes to predicting how families will really behave.

Here’s a case in point: The most recent Reuters/University of Michigan consumer sentiment survey, released on Oct. 14 showed that the mood of households continued to worsen in mid-October, even as the stock market showed new signs of life.

“Consumer confidence is inching itself deeper into the recession zone,” said Chris G. Christopher Jr., senior principal economist at IHS Global Insight.

Yet the most recent government data show that retail sales jumped a larger-than-expected 1.1 percent in September. In short, actual consumer spending would seem to point to a much rosier economic outlook, which in turn should help support hopes for a more stable stock market.

Jeffrey Kleintop, chief market strategist at LPL Financial, says the recent mood of households doesn’t seem to reflect some of the positive economic numbers that have been released lately.

“The data on earnings, the economy, and the news out of Europe is not great,” he says. “But it is great relative to sentiment.”

He adds that “the only time the gap between economic data and economic sentiment was as wide as it was in the past couple of months was in late 1999 and early 2000 when the opposite of the current situation was the case: sentiment was much more positive than the data.”

It’s not just retail spending that market strategists are watching.

Despite concerns about the outlook of consumers, the S. P. 1500 retail index has showed surprising strength this year — it is up more than 7 percent. In fact, this group of stocks is only around 2 percent below its record high.

Similarly, the S. P. consumer discretionary index — which tracks shares of S. P. 500 consumer companies that make goods that households want, not need — has soared 16 percent since the market bottomed on Oct. 3, outpacing the broad market.

“This does point to the expectation now, at least from investors, that we are going to avoid a new recession,” said Doug Ramsey, chief investment officer at the Leuthold Group, an investment management and advisory firm.

To be sure, this doesn’t necessarily mean that the stock market has regained its footing. Historically, Mr. Ramsey notes, the severity of bear markets that are associated with recessions is actually quite similar to downturns that occur during times of economic growth.

Nor does it mean that the recent bout of market volatility will be over soon.

But it does mean that the gloomy mood among many investors could turn out to be good for the market in the short term.

In the long run, will that be enough to counteract the real economic worries that are weighing down the market, particularly the continuing fiscal mess in Europe? That’s a discussion for another day.

Paul J. Lim is a senior editor at Money magazine. E-mail: fund@nytimes.com.

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