Is ISM a Contrarian Indicator?

September 2, 2014 10:27 AM

In 2011, the last time that the ISM indicator hit levels that it registered this morning, I remember reading that the index has some contrarian tendencies at extremes.  In other words, stocks tend to rise after extremely weak readings and tend to fall after extremely strong readings.  Here’s some data to help verify that claim.

Below is a chart of how the S&P 500 has fared in the year after extreme ISM readings.  When the index crosses above 59 from a lower level, the S&P 500 has tended to rise over the next 12 months, but at a relatively slow pace, just 1.6%.  The index declined 10 out of 28 times.  On the other hand, the index has tended to rise significantly when the ISM index crosses below 41.  The index has risen 9/10 times that has happened, and risen by an average of 15.8% over the next year.

If you subscribe to a contrarian view of markets, this may make sense.  The ISM survey is an indicator of sentiment, because it asks operators how they feel about business.  When the index is extremely high, it may indicate that people are overly optimistic.  When the index is extremely low, it may indicate that people are overly pessimistic.

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