Stocks are rallying, but investors say they’re miserable. That’s a good thing.

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Futures on Friday suggest the S&P 500?SPX,?+0.94% ?may pop its head through the 4,200 level again, looking to decisively break above the 400-point trading range in which it has twitched for nearly seven months.

Easing angst over U.S. regional banks and the government debt-ceiling, combined with calmer conditions in bond markets as traders welcome cooling inflation and a Federal Reserve rate-hike pause, are all underpinning sentiment.

We even have a fresh structural paradigm for bulls to feast on. Hopes for an AI bonanza have helped push the Nasdaq Composite?COMP,?+1.51% ?to its highest since August.

Just look how optimistic people are! Nasdaq 100 call option volume has hit its highest since 2014:

But hold on. All this is all happening while?people say they are downright miserable about the market . Even those who are active investors reflect sentiment at depressed levels.

That’s fine, because the dichotomy in fact implies further market gain, says George Smith, portfolio strategist at LPL Research.

According to the latest weekly data from the American Association of Individual Investors (AAII) the percentage of individual investors who are bullish about short-term market expectations is 23%, down from 29% last week.

“This marks the lowest level since the end of March and is well below the long-term average of 34%,” says Smith. The percentage of investors who are bearish decreased week-on-week to 40%, but was still well above the long-term average of 32%, he adds. This puts the spread between the bulls and the bears at minus 17%, versus a long-term average of plus 2%.

As the chart below shows, investor sentiment, as measured by the spread between bulls and bears in the AAII data, is more than one standard deviation below its long-term average.

“While the concerns that are feeding into the individual investors’ ‘wall of worry’ [lingering inflation, higher interest rates and recession fears] are valid, the negative sentiment they have built up is, from a contrarian perspective, a potential catalyst for positive forward returns,” says Smith.

Indeed, this chart from Vanda Research shows how retail investors in particular have reduced stock purchases since SVB went bust.

In other words there is support for stocks, as many potential buyers wait in the wings for current worries to subside, says LPL’s Smith.

“Extremes in pessimism in the AAII data are, on average, bullish for near-term stock market returns (and extreme investor optimism tends to be bearish for the near-term outlook). When the bull-bear spread is around where it is now (between 1 and 2 standard deviations below average), we have seen the strongest S&P 500 returns three months and 12 months out, and the second strongest returns six months out,” says Smith.

Markets

Stock index futures?ES00,?0.31% ?YM00,?0.25% ?NQ00,?0.16% ?are higher and Treasury yields?TMUBMUSD10Y,?3.709% ?a touch softer. The dollar?DXY,?-0.31% ?is weaker, helping gold prices?GC00,?0.25% ?firm while crude futures?CL.1,?1.84% ?are also gaining ground.

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