Darkest Before the Dawn

• AAII investor sentiment flipped decidedly negative last week.

• The bull versus bear spread fell below the -20 level.

• Past cycles have led to above-average S&P 500 returns.

Bull markets don't die in fear; they die in euphoria...

Turn on the financial news or scroll through Wall Street research and you'll hear the same refrain: inflation is back, and the Federal Reserve's path to further rate cuts keep getting pushed out. Geopolitical risk in the Middle East is exhibit A, with the fear that a wider conflict chokes off oil supply, reignites inflation, and forces global central banks to rapidly raise interest rates.

But the picture often looks to be at its worst right before the tide turns. And this week, there are early signs it may be doing just that.

Recent statements out of the White House suggest President Trump would be open to sitting down with Iran's president, Masoud Pezeshkian, while both are in New York for this week's UN General Assembly. It's not a resolution, but a willingness to talk is a meaningfully different posture than the market has been pricing in.

Meanwhile, despite months of media speculation that oil supply through the Strait of Hormuz was being choked off, sources in the region tell a different story. U.S. Central Command's Admiral Brad Cooper said this past week that oil and LNG shipments through the Strait hit their highest level in six months, and primary transit lanes now confirmed clear of mines. Saudi Arabia’s backing that up: satellite imagery tracked by Bloomberg shows the Kingdom loading the highest number of tankers at its Gulf export terminals in several weeks. That’s despite a drone strike knocking out its East-West pipeline and forcing more volume back through Hormuz.

Put together, the situation may not be as dire as some corners of the media suggest. And if the U.S. and Iran can find any kind of path forward, that supports an outlook for even more energy flowing through the Strait. Increased supply weighs on the global oil price and inflation outlook. The change would mean means less impetus for additional central bank rate hikes. The combination should underpin a steady rally in the S&P 500 Index.

But don't take my word for it, let's look at what the data's telling us...

Every so often, the market hands us a signal that's easy to overlook in the week-to-week noise but meaningful when you zoom out. One of those signals just flashed again last week. The American Association of Individual Investors’ (“AAII”) Bull-Bear Spread fell to -24.5. For most investors, this might sound like a footnote. But historically, this pattern has been a reliable sentiment inflection point for forward equity returns.

To understand why the AAII signal matters, it helps to consider what the survey captures. Each week, individual investors report whether they feel bullish, bearish, or neutral about the stock market over the next six months. On its own, the survey can be noisy. But when the spread moves decidedly negative - meaning pessimists greatly outnumbered optimists - it often reflects a deeper emotional exhaustion in markets. Investors have already braced for bad news. And when that deep bout of negativity finally flips back to positive, it has historically marked the beginning of stronger equity performance.

This pattern has appeared 67 times going back to the start of 2000. That alone makes it notable: markets don't hand out many clean, repeatable sentiment signals. What makes these episodes compelling is what tends to happen next. Historically, when the Bull-Bear Spread turns this negative, the S&P 500 has delivered strong forward returns...

Twelve months after the signal, the S&P 500 has averaged an increase of 15.1% on a price return basis, with a median return of 17.4%. That's better than the 8.1% average annual gain for the gauge since 1928. Even more striking is the success rate: in the instances where 12-month data is available, the market has rallied 80% of the time. And in the cases where 24-month data exist, 87.3% of them were positive, with a typical gain of 34.8%.

These are not small numbers. They're not statistical quirks. They're the kind of outcomes that speak to the power of sentiment reversals and the power of staying invested when pessimism is widespread.

We've already seen this dynamic play out recently. The last time this signal triggered, with a full year's worth of follow-up data, was September 10, 2025. At the time, investors were still digesting inflation volatility, geopolitical tension, and a soft patch in earnings revisions. Investor sentiment was deeply negative. Twelve months later, the S&P 500 has gained 16.2%, outperforming even the historical average.

Now, a new signal was triggered last week. It's too early to measure forward returns, but the setup is familiar: extended pessimism giving way to early signs of optimism, even as headlines remain mixed and investors remain cautious. Historically, that combination has been fertile ground for long-term gains.

Bottom line: when the AAII Bull-Bear Spread has turned this negative in the past, it has often marked the beginning of strong equity performance over the next one to two years. No signal is perfect, and history never guarantees the future. But the pattern is clear. Pessimism eventually exhausts itself, optimism returns, and markets tend to move higher. For long-term investors focused on compounding, these are the moments that matter.

Five Stories Moving the Market:

Meta Platforms' new AI assistant, Muse, has topped the mobile app charts with more than 902,000 downloads in the six days after its September 8 launch, a sign Meta is gaining traction in the crowded consumer AI assistant market – Bloomberg. (Why you should care – Muse's early traction lifted chip stocks on the belief that it could be the catalyst for bringing agentic AI to the masses) 

Federal Reserve Bank of Chicago President Austan Goolsbee warned the central bank cannot ignore repeated and persistent supply shocks, and must respond in a way that may cause economic hardship – FT. (Why you should care – Goolsbee, who is not a policy voter this year, said more hikes may be necessary if the supply shocks remain persistent)

Germany's far right and far left both made big gains in this past weekend's state elections, exposing yet again the erosion of the political center in Europe's largest economy as ​well as Chancellor Friedrich Merz's weakening hold on power – Reuters. (Why you should care – the election outcome is likely to drive more government spending in Germany, causing its debt-to-GDP ratio and borrowing costs to rise)

New Zealand’s central bank should place more emphasis on the inflation-adjusted level of the Official Cash Rate when it sets monetary policy, according to an independent review; it highlighted vulnerabilities in the RBNZ’s monetary policy strategy that became exposed when an economic shock struck – Bloomberg. (Why you should care – increased focus on the real rate of interest should inhibit central banks from allowing monetary policy to become too tight or too loose)

The United States, Denmark and Greenland said they had reached an agreement for the U.S. to expand its military footprint in the self-governed Danish territory, while preventing U.S. adversaries from establishing bases there – Reuters. (Why you should care – the White House is trying to maintain oversight of a vital naval passage in the North Atlantic as well as keeping adversaries from gaining access to region’s critical minerals)

Economic Calendar:

Earnings: AZO

Markets in Japan are Closed

U.S. - ADP Employment Change (Weekly) (8:15 a.m.)

U.S. - Richmond Fed Manufacturing and Services Surveys for September (10 a.m.)

Fed's Williams (New York, Voter) Speaks (10:05 a.m.)

Fed's Jefferson (Board, Vice Chair) Speaks (10:20 a.m.)

Treasury Auctions $69 Billion in 2-Year Notes (1 p.m.)

U.S. - M2 Money Supply for August (1 p.m.)

Fed's Barkin (Richmond, Non-Voter) Speaks (1 p.m.)

U.S. - American Petroleum Institute Crude Oil Inventory Data (4:30 p.m.)