“Market timers can’t be much more optimistic, which is bearish from a contrarian perspective.”
The stock market rally has lost almost all support due to the contrarian analysis. That's because most of the cash in stock portfolios that used to sit by the wayside is now back on the market, leaving little additional cash available to invest and prices rising significantly in the coming months will drive up.
In fact, many of the short-term stock market timers my accounting firm monitors are more optimistic today than at almost any time since data collection began in 2000.
Consider the timers that focus on timing the broad market as represented by market averages such as the Dow Jones Industrial Average DJIA and the S&P 500 SPX. Their average recommended stock exposure is currently higher than it has been in just 0.7% of trading days since 2000. The timers can't be much more bullish than what contrarian analysis says is bearish.
The timers' upward trend is illustrated in the chart below, which plots the timers' average recommended stock exposure level by the Hulbert Stock Newsletter Sentiment Index (HSNSI). The shaded zone at the top of the chart reflects the range of HSNSI values that have been in the top 10% of their distribution since 2000; In previous columns, I have used this area to indicate excessive optimism.
You'll notice that the HSNSI entered this upper decile zone more than a month ago and the stock market continued to rise contrary to contrarians' expectations. One possible explanation for this surprising strength is that certain other market participants – those focused on the Nasdaq market in particular – remained significantly less optimistic. In retrospect, the relative caution of these timekeepers may have been enough to give the rally room to run.
For example, as recently as mid-December, my company's Hulbert Nasdaq Newsletter Sentiment Index (HNNSI), which reflects the average recommended stock exposure of these Nasdaq-focused timers, was firmly in the middle of its historical distribution. That is no longer the case: the HNNSI is now at the 92nd percentile of its historical distribution, joining the HSNSI in its respective zones of excessive optimism. (The HNNSI is not shown in the attached diagram.)
Of course, this deteriorating sentiment does not guarantee that the market will immediately stumble. Contrarian analysis is not the only factor driving the market, and even when contrarian analysis is effective, the market does not always respond immediately. For example, in the coming days, as I suggested last week, stocks could rise slightly during the Santa Claus rally into early January before eventually succumbing to the pull of excessive optimism.
But even if the future is like the past, the US market's recovery is increasingly living on borrowed time.
Mark Hulbert is a regular contributor to MarketWatch. Its Hulbert Ratings tracks investment newsletters that charge a flat fee to review. He can be reached at [email protected]
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