This sell signal for stocks just hit most extreme level in 5 years

Bank of America‘s Bull & Bear Indicator has just flashed its biggest “sell” signal since at least 2021.

“Extreme bull positioning says reduce risk exposure,” Michael Hartnett, the bank’s chief investment strategist, said in a note on Friday.

The indicator takes into account hedge-fund positioning, equity and bond flows, stock index breadth, fund manager positioning, and credit market technical indicators. When these gauges show that investor sentiment is over-exuberant, they flash a contrarian sell signal.

The signal isn’t necessarily a predictor of major, drawn-out sell-offs in the broader market. Instead, it tends to signal near-term danger.

For example, after its peak in February of this year, the S&P 500 dropped more than 7% — since the end of February, though, the market is up 9%. And at its peak in May 2010, the market underwent a “flash crash” of 9%, but the broader bull-trend remained intact.

According to Bank of America, there have been 17 sell signals since the Bull & Bear Indicator was launched 24 years ago.

Hartnett said that average sell-off of the MSCI All Country World Index after a sell signal has been 2% to 3% over the following two to three months, and that stocks have fallen 60% of the time. The maximum declines in the following few months have been in the 15% to 20% range, Hartnett said.

In May, Hartnett warned of a potential bubble in stocks, and said consumer staples, financials, and healthcare stocks should outperform. In recent weeks, the bank also said the S&P 500 could see a correction in the third quarter.

Morningstar has also recently flagged a concerning investor sentiment indicator: the stellar performance of the S&P 500 Momentum Index. In April and May, it had its best two-month stretch of returns since at least the mid 1990s, surpassing peaks seen during the dot-com era.

Since the momentum index holds stocks that have done well recently, it acts as a defacto gauge on FOMO level in the market.

“I think it’s one signal that there might be excessive optimism in the market today, and so I think it leaves us with a cautious outlook for markets from this point on,” Morningstar Wealth CIO Philip Straehl told Business Insider this week.