Market Optimism: A Contrarian’s Perspective
Despite the recent decline in the US stock market, there are reasons to believe that this is not the start of a major bear market. A closer look at stock-market-timer sentiment reveals that market timers have been extremely optimistic in recent months, making a pullback overdue.
The Bullish Sentiment Index
The Hulbert Stock Newsletter Sentiment Index (HSNSI), which tracks the average recommended equity exposure level among short-term stock-market timers, stood at an all-time high of 92.8% on December 4, the day of the Dow Jones Industrial Average’s all-time closing high. However, following this week’s plunge, the HSNSI fell to 37.1%, a drop of 56 percentage points.
A Historical Perspective
To put this drop into perspective, I analyzed stock-timer sentiment at the beginning of the five bear markets after 2000. In none of those bear markets did the HSNSI fall by as much as 56 percentage points over their first 10 trading sessions. The average decline was 25 percentage points.
A Near-Term Reprieve
This suggests that the current pullback may not be the start of a major bear market. Instead, it may be a necessary correction to wring out some of the excess optimism in the market. However, longer-term worries remain, given the extraordinary optimism of the market-timing community in recent months.
The Warning Signs
One illustration of this exuberance is the chart below, which plots each year’s average HSNSI level since 2000. This year’s average sentiment-index level is the highest of any in the past 24 years. This sustained exuberance means that the next bear market will most likely be a particularly severe one.
The Road Ahead
While the near-term outlook may be more positive, investors should remain cautious and prepared for a potentially severe bear market in the future. It’s essential to maintain a balanced portfolio and be prepared to adapt to changing market conditions.
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