Stocks just got a majorly bullish signal

In recent decades, US consumer sentiment has proven fickle, gyrating unexpectedly and generally keeping investors on their toes.

But when it’s stayed high for a prolonged period, it’s historically unlocked massive gains for stocks.

That’s exactly what’s happening right now. In fact, we’re about halfway into one of those high-confidence periods, after University of Michigan Consumer Sentiment Index data last Friday kept the trend intact.

Sentiment has only been this high for this long on five other occasions since 1978, according to data compiled by Morgan Stanley. The S&P 500 saw a median return of 21% in the one year following each positive reading, and a 42% gain over a two-year period, the firm’s data show.

The S&P 500’s 17% rally since June 2016 shows the benchmark’s ongoing rally is roughly in line with history. And perhaps more importantly for market speculators, it signals that the index could have anywhere from 21% to 25% left to climb over the next year.

“This suggests that an environment of elevated and stable consumer sentiment is conducive to a building of animal spirits,” a group of Morgan Stanley equity strategists wrote in a client note on Tuesday. “This trend started last year, but still has momentum.”

In order for University of Michigan consumer sentiment to be considered elevated and stable by Morgan Stanley’s standards, it has to meet these two qualifications:

  • The 10-month rolling average is above 90 (for context, last month’s reading was 97.1)
  • The year-over-year change is not greater than 10%, nor less than -10%, for 10 straight months

Also working in the S&P 500’s favour is the seven-day streak of gains it enjoyed through last Friday. Consecutive increases to that degree have only occurred 17 times since May 1997, and the benchmark has historically surged an average of 12% over the subsequent year, according to Nautilus Investment Research. That’s more than double the return seen over all normal periods of similar length, the data show.

Of course, no bullish stock market discussion would be complete without a mention of earnings growth. As of right now, S&P 500 companies are on pace to see 14% earnings growth for the first quarter of 2017, the most since the third quarter of 2011, according to data compiled by Bloomberg. It marks the third straight period of earnings growth for the S&P 500, which comes after a five-quarter earnings contraction.

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