There is finally enough pessimism on Wall Street to make contrarian-minded investors take notice.
Contrarians turn bullish when the prevailing mood is extreme pessimism, and there was insufficient pessimism up until just the last few days. A month ago, I concluded after analyzing senitment that “it’s still too early to jump back into stocks.”
The sentiment picture today is markedly different. Even though the stock market today is more or less at the same level it was a month ago, the average market timer is significantly more bearish. That’s a good sign from a contrarian point of view.
This increased pessimism is evident in both of the stock market sentiment indexes that I maintain. The first represents the average recommended equity exposure level among short-term market timers who focus on the Nasdaq market (as measured by the Hulbert Nasdaq Newsletter Sentiment Index, or HNNSI). On the occasion of my month-ago column, this average recommended exposure level was minus 25.9%, which means that the average Nasdaq-focused timer was allocating 25.9% of his equity portfolio to going short.
Today, in contrast, with the market at essentially the same level as it was then, the HNNSI stands at minus 38.9%.
Perhaps even more revealing is the latest reading from my other sentiment indicator, which reflects the average recommended exposure level among short-term timers who focus on the broad stock market. This other indicator is the Hulbert Stock Newsletter Sentiment Index, or HSNSI. This index is less volatile, and rarely has it fallen into negative territory.
Just in the last few trading sessions, however, the HSNSI has gone negative. In fact, it’s now more negative than at any time since the severe market correction (some say bear market) that bottomed in February 2016. (See accompanying chart.)
The stories told by both of these sentiment indicators is definitely encouraging.
What has really caused contrarians to pay attention is how those indicators have reacted to the market’s strength over the past week. Even though the major stock market averages are between 3% and 4% higher than their Oct. 29 lows, both the HNNSI and HSNSI are lower. That suggests that the average market timer has reacted to the market’s recovery strength by turning even more bearish.
That’s extremely bullish behavior, according to contrarian analysis, because it suggests that the prevailing mood is particularly pessimistic.
The usual qualifications apply, of course. Contrarian analysis isn’t always right, and even when it is it only applies to the short term — no more than the next month or two. So today’s encouraging sentiment picture tells us nothing about where the market might be six months to year from now.
But, for now at least, contrarians are betting that the stock market will higher over the next couple of months.