Neutral Sentiment Surge and Bearish Extremes: A Contrarian's Signal for a Market Turnaround?

The AAII Sentiment Survey for the week ending May 28, 2025, revealed a striking divergence in investor psychology: 57.1% of respondents described themselves as bearish, while neutral sentiment surged to 23.6%—both figures marking critical inflection points in market sentiment. For contrarian investors, this combination of extreme pessimism and rising indecision could signal a rare opportunity to position for a rebound.

The Bearish Overhang: Historical Context and Contrarian Logic

The 57.1% bearish reading is the fourth-highest since 2009, trailing only the 61.9% peak in April 2025 and the 60.6% surge in late 2022. Historically, such extremes have acted as contrarian buy signals. For example, after the 60.6% bearish reading in February 2023, the S&P 500 rose 15% over the next 12 months. The current bearish sentiment has now exceeded its historical average of 31.0% for the 14th time in 16 weeks, a streak last seen during the 2022-2023 downturn.

The data underscores a pattern: prolonged bearishness often coincides with market bottoms. When the bull-bear spread (bullish minus bearish) dips below -35%, as it did this week (-37.8%), the S&P 500 has historically outperformed its average returns over the next three to 12 months.

Neutral Sentiment: A Pause or a Pivot?

The 23.6% neutral sentiment—up 3.6 percentage points from the prior week—suggests investors are hesitating between outright pessimism and cautious optimism. This is the 33rd week in 35 where neutral sentiment has lagged its 31.5% historical average, indicating a market in “no man's land.”

The survey's special question revealed behavioral shifts: 28.9% of investors became “much more conservative,” and another 26.9% adjusted toward caution. Only 4.9% grew more aggressive. This mass exodus from risk-taking aligns with contrarian principles: when fear dominates, greed often follows.

Tactical Allocations: Where to Look Now

For contrarians, the current environment favors value and dividend stocks, which have historically thrived during market corrections. The survey's data coincides with a backdrop of 33 mid-cap dividend payers meeting stringent criteria for valuation, growth, and dividend strength—a sign of resilience in defensive sectors.

Consider sectors like utilities, healthcare, and consumer staples, which often outperform during volatility. For example, the Utilities Select Sector SPDR Fund (XLU) has a dividend yield of 3.8% and a P/E ratio below its five-year average.

Risks and Caution: Avoiding the “Buy the Dip” Trap

While the contrarian case is compelling, investors must avoid overreacting to short-term pessimism. Key risks include persistent inflation, geopolitical tensions, and the Federal Reserve's stance on interest rates. Awaiting confirmation from technical indicators—such as a sustained break above the 200-day moving average—could mitigate timing risks.

Final Take: A Bottom in the Making?

The AAII data paints a clear picture: extreme bearish sentiment and rising neutrality are hallmarks of a market near its lows. History suggests that buying when fear is peaking can yield outsized returns. However, success hinges on patience and discipline.

Action Items for Contrarians:
1. Allocate incrementally to value-oriented sectors, focusing on dividends and strong balance sheets.
2. Avoid overcommitting to cyclical stocks until broader macroeconomic clarity emerges.
3. Monitor technicals: A close above the S&P 500's 200-day moving average (around 4,600) would confirm a bullish shift.

In conclusion, the AAII's extreme bearish reading and neutral surge are not red flags but green lights for contrarians. While risks remain, the data suggests this pessimism may soon invert—and the most fearful days could mark the start of a new bull market chapter.