The bull market may be getting old, but it still has more life.
That is the conclusion contrarians could reach now given market timers’ reaction to the U.S. market sell-off last Monday and Tuesday. Many of them quickly ran for the exits, in the process rebuilding the wall of worry that bull markets like to climb.
At major market tops, in contrast, the typical pattern is for the market-timing community to remain stubbornly bullish.
Consider the average recommended stock market exposure level among a subset of Nasdaq-focused market timers I monitor (as measured by the Hulbert Stock Newsletter Sentiment Index, or HNNSI). This average currently stands at 42.9%, which is 28 percentage points lower than where it stood earlier this week. And it is 46 percentage points lower than its level from the middle of the previous week. (See chart.)
Such big drops in such a short period tell us that there is a large undercurrent of worry on Wall Street. This is crucial information, because we otherwise would think that bullish sentiment is at an extreme.
As I’ve noted before, the bullishness that currently prevails is a mile wide and only an inch deep. At the first hint of trouble, many of the bulls are quick to throw in the towel.
We can thank the recent market drop for affording us this insight. Without it, we would have had no way of knowing whether the bulls had become stubbornly confident in the bull market’s future (which would have been bearish from a contrarian point of view) or, instead, were Nervous Nellies (which is bullish).
Now we know, of course. And that means the bull market most likely has not yet breathed its last breath.
To be sure, this upbeat forecast applies only for the near term. The stock market remains seriously overvalued, and risk is therefore high.
But, assuming sentiment at the bull market’s eventual top adheres to the historical pattern, that top will be accompanied by a lot more stubbornly held bullishness than we’re seeing now.
If you want an illustration of what stubbornly held bullishness looks like in practice, consider how the Nasdaq-oriented timers responded in early 2000 to the internet bubble’s bursting. In just the first two weeks of that bubble’s deflation, the Nasdaq Composite COMP, -0.35% fell by enough to satisfy the semi-official definition of a correction — more than 10%. The equivalent-sized drop today would take more than 2,600 points off the Dow Jones Industrial Average DJIA, +0.14% and almost 740 points from the Nasdaq Composite.
Big as that March 2000 drop was, however, the Nasdaq-focused market timers treated it as a buying opportunity rather than as a reason to run scared. The HNNSI actually jumped by more than 30 percentage points over those two weeks.
That’s not what we’re seeing now, of course, which is why contrarians give the bull market the benefit of the doubt — for awhile at least.
For more information, including descriptions of the Hulbert Sentiment Indices, go to The Hulbert Financial Digest or email mark@hulbertratings.com .