In This Article:
The U.S. stock market’s decline this week most likely does not signify the start of a major bear market.
This optimism is based on a contrarian analysis of stock-market-timer sentiment. Market timers, on average, have been extremely exuberant in recent months, and a pullback was overdue. But this week’s selling pushed many of the timers out of stocks, and that isn’t typical of a major market top.
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This is illustrated by the average recommended equity exposure level among several dozen short-term stock-market timers who focus on timing the broad stock market. (This average is what’s reflected in the Hulbert Stock Newsletter Sentiment Index, or HSNSI.)
On Dec. 4, the day of the Dow Jones Industrial Average’s DJIA all-time closing high, this average stood at 92.8% — higher than any other daily reading since at least April 2000 (which is how far back the data extend). In the wake of this week’s plunge, the HSNSI fell to 37.1%, a drop of 56 percentage points. That’s a big drop in bullishness over just 10 trading days.
To put the magnitude of the HSNSI’s plunge in perspective, I analyzed stock-timer sentiment at the beginning of the five bear markets after 2000 in the bear-market calendar maintained by Ned Davis Research. (I ignored the bear market that began in early 2020 because of the COVID-19 pandemic, since it was exceptional in so many ways.)
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.
This is encouraging, because a hallmark of major market tops is a reluctance on the part of the bulls to treat the pullback as anything more than a pause. If the eventual end of the current bull market follows historical patterns, the final top will be accompanied by significantly more bullish stubbornness than we’re seeing now.
Long-term troubles
These positive signs apply only to the near term, however. Longer-term worries remain, given how extraordinarily optimistic the market-timing community has been in recent months. One illustration of their exuberance is the chart below, which plots each year’s average HSNSI level since 2000. Notice that this year’s average sentiment-index level is the highest of any in the past 24 years.