Contrarian analysis suggests that the current surge of bullishness among market-timers may actually be a bearish signal for the stock market. The rally in the market has seen a significant decline in support from this contrarian perspective. Previously, a substantial amount of cash in equity portfolios remained on the sidelines, providing additional fuel for future price increases. However, recent data shows that this sideline cash is now back in the market, reducing the available funds for further investment and pushing prices to new heights.
The level of bullishness among short-term stock market timers, as monitored by our auditing firm, is currently at an all-time high since data collection began in 2000. This is particularly notable for timers who focus on timing the broad market, such as the Dow Jones Industrial Average (DJIA) and the S&P 500 (SPX). The average recommended equity exposure level of these timers is now higher than it has been on just 0.7% of trading days since 2000. This extreme bullishness, according to contrarian analysis, can actually be seen as a bearish indicator.
To visually represent this overwhelming bullish sentiment, we've included a chart below. The chart depicts the average recommended equity exposure level of the timers, using the Hulbert Stock Newsletter Sentiment Index (HSNSI). The shaded zone at the top of the chart represents readings that fall within the top 10% distribution since 2000. In previous columns, we have used this zone to indicate excessive optimism. With the current HSNSI readings reaching this shaded zone, it becomes evident just how bullish market timers have become.
The implications of this extreme bullishness are significant. While it may suggest short-term gains in the market, contrarian analysis warns that such excessive optimism often leads to a market correction. As a professional copywriter with years of experience, I encourage investors to consider these contrarian signals and exercise caution in their investment strategies.
A Closer Look at Stock Market Sentiment
Investors may have been surprised to see the stock market continue to rise, even after the Hulbert Nasdaq Newsletter Sentiment Index (HNNSI) entered into the top decile zone more than a month ago. Contrary to what contrarians may expect, this unexpected strength in the market could be attributed to the cautious approach taken by market timers focusing on the Nasdaq market.
As recently as mid-December, the HNNSI, which reflects the average recommended equity exposure of Nasdaq-focused timers, was positioned in the middle of its historical distribution. However, the sentiment has taken a turn since then. Currently, the HNNSI stands at the 92nd percentile of its historical distribution, putting it in the same zone of excessive optimism as the HSNSI (Hulbert Stock Newsletter Sentiment Index). It is worth noting that the HNNSI is not depicted in the accompanying chart.
It is important to understand that the deteriorating sentiment does not necessarily mean an immediate stumble for the market. While contrarian analysis plays a role in market movements, it is not the sole determining factor. Even when contrarian analysis is accurate, the market does not always respond immediately. In the upcoming days, stocks may continue to rally, especially during the Santa Claus rally period through early January (as mentioned in last week's analysis). However, eventually, the gravitational pull generated by excessive optimism could lead to a market correction.
Although nothing is certain, looking back at historical trends suggests that the current rally in the U.S. market may be running out of steam.
More: The 10 Most Significant Stock Market Moves of 2023
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