Wall Street is taking the other side of individuals' pessimism

Key points:

• Wall Street strategists expect the S&P 500 to gain about 5% over the next year
• Nearing year-end, this kind of discount has tended to lead to higher prices for the index

Strategists have modest (but positive) expectations for the S&P 500

We saw on Monday that individual investors are pessimistic. Wall Street isn't - analysts are busy upgrading price targets, and strategists expect the S&P 500 to add to its gains in the new year. Strategists' average price target for the S&P 500 over the next year is nearly 5% higher than where the S&P was on Monday, suggesting the index is undervalued. LOL.

There are a whole host of caveats with this, including that Bloomberg only sporadically surveys Wall Street, so this could change quickly, but their estimates would likely be increased, not decreased.

Based on current figures, when the S&P is more than 4.5% below strategists' year-ahead estimated price, the index returned an annualized +9.5%, versus a wretched -9.8% when the index was at least 4.5% above strategists' estimate.

Looking at all years when there were 3 trading days left in the year, and the S&P was within 1% of a multi-year high, this is one of a handful that shows the S&P was still undervalued. And that was mostly a good sign for forward returns, especially in the first couple weeks of the new year. The only loser, in early 2015, reversed its losses in February.

There were only 3 years when the S&P was within 1% of a high, and strategists thought the index was overvalued. All preceded declines.

When the S&P was further from a high (mostly bear market environments), forward returns were significantly worse even if strategists thought the index was undervalued.

What the research tells us...

Wall Street analysts and strategists are considered among the smartest of smart money. That isn't always the case, but when it comes to strategists, the S&P 500 does tend to revert toward their price targets over time. Granted, they have a 9% return as a baseline and rarely stray too far. When the S&P gets too far above or below their estimates, the index tends to snap back. The idea that it's currently about 5% below strategists' estimates suggests it has more room to rally.