Monday, January 25, 2016

Investors Are Still Far Too Bullish Despite The Stock Market Correction...........

Investors Are Still Far Too Bullish Despite The Stock Market Correction

The proof: They cheered Wednesday's late-day rally even though equities tanked.

The stock market's plunge won't come to an end until pessimism and despair become a lot more widespread.

And that could be a while, since the stock market timer community has been exhibiting a stubborn refusal to throw in the towel.

We saw this behavior in spades Wednesday, when the Dow Jones Industrial Average by the middle of the trading session had fallen by more than 500 points — only to recover and close down "only" 250 points. Rather than bemoan the loss for the session, many were quick to celebrate that late-day recovery, and some even declared that Wednesday was a so-called short-term reversal day, which would be positive from a technical perspective.

Such eagerness to believe any rally attempt as the real thing is characteristic of bear markets, according to contrarian analysis. As contrarians are fond of saying, bear markets like to descend a slope of hope, just as bull markets like to climb a wall of worry. From this contrarian perspective, therefore, a more sustainable bottom will come when there is no such eagerness.

Consider the average recommended equity exposure among a subset of short-term Nasdaq-oriented stock market timers monitored by the Hulbert Financial Digest (as measured by the Hulbert Nasdaq Newsletter Sentiment Index, or HNNSI). Since the Nasdaq responds especially quickly to changes in investor mood, and because those timers are themselves quick to shift their recommended exposure levels, the HNNSI is the Hulbert Financial Digest's most sensitive barometer of investor sentiment.

The HNNSI through Wednesday of this week never fell below minus 37.5%. While this is low in absolute terms, it is not in relative terms: As you can see from the chart below, this was well above the minus 50% level to which it fell during the market's correction last summer.

To be sure, on Thursday, the HNNSI did drop down to minus 50%. But, given the market timers' prior eagerness to jump on the bullish bandwagon, contrarians won't entertain the notion of a tradeable bottom until the HNNSI stays at least that low for several days in a row.

An especially bullish development, from a contrarian perspective, would be for the market timing community to remain as bearish as it is now in the face of the market's initial rally attempt. That would suggest that, finally, the market's plunge over the past several weeks has led to a robust wall of worry that the market can climb.

The HNNSI is not the only sentiment measure that leads to a contrarian-based caution about the market's rally attempts. During the market's recent plunge, for example, the CBOE's Volatility Index VIX, -11.32% never closed higher than $27.59, in contrast to spiking to over $40 in August.

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