- Professional investors' pessimistic views of the stock market has hit extreme levels.
- Bank of America's fund manager survey showed cash levels among investors is at the highest level since 2001.
- The confluence of extreme pessimism suggests the stock market will rally in the second half of the year, BofA said.
The stock market is poised for a contrarian rally in the second half of the year as professional investors grow more and more bearish, Bank of America said in a note on Tuesday.
The bank's most recent fund manager survey revealed that professional investors haven't been this pessimistic towards equities since the downfall of Lehman Brothers during the 2008 Global Financial Crisis. And that's not the only bearish indicator that is flashing at extreme levels.
Cash levels among fund managers surged to the highest level since late 2001, shortly after the September 11 terrorist attack. Additionally, expectations for global growth and profits plunged to an all-time low, and fund allocations towards stocks dropped to the lowest level since 2008.
Finally, BofA's Bull/Bear indicator continues to flash a reading of zero, which is the most bearish it can get.
"July BofA Fund Manager Survey shows dire level of investor pessimism," BofA's Michael Hartnett said.
The extremely bearish outlook comes as investors have been pelted with bad news after bad news this year. High inflation, fast-rising interest rates, and a decline in profit growth expectations has dented investor enthusiasm considerably.
But such bearish extremes also set the stock market up for a contrarian rally in the second half of the year, even if the fundamentals don't look particularly positive.
"I'm so bearish, I'm bullish," Hartnett said.
Hartnett believes a contrarian rally for the stock market could materialize in the third quarter as long as inflation shows signs of slowing down, there's no financial disaster akin to Lehman Brothers' bankruptcy, and if the Federal Reserve pauses its interest rate hikes by Christmas.
Similar to last month's move, the Fed is expected to raise interest rates by another 75 basis points at its next meeting in late July. That's a step-down from prior expectations of a 100 basis point rate hike earlier this month when inflation data showed prices rising at a near-record pace again in June.
All in, the takeaway from BofA is that when an overwhelming majority of investors lean too far to one side of the bullish-bearish spectrum, the opposite tends to happen. With investors so bearish on stocks given the headline risks, don't be surprised if stocks begin to inch higher in the second half of the year as sellers are exhausted.