The bloodletting still has further to go. This bad news come from a contrarian analysis of short-term market timers, who on balance have not yet exhibited the utter despair and pessimism that is the hallmark of a tradable bottom.
The good news, however, is…
that we’re getting closer.
Consider the average recommended equity-market exposure levels among a group of several dozen short-term stock market timers I monitor (as measured by the Hulbert Stock Newsletter Sentiment Index, or HSNSI). Though this average has declined dramatically over the last couple of weeks, it has yet to fall to levels seen at the bottom of prior corrections.
This is well illustrated in the chart above. Notice in particular how far the HSNSI fell in December 2018, which was the bottom of the market’s correction (or bear market, depending on how you define it) that began in September of that year. With the benefit of hindsight, what we were worried about then seems almost quaint: Our concern about interest rates seems in retrospect to have all the significance of your kids’ arguments about crunchy versus creamy peanut butter.
Yet our memories play tricks on us. Believe it or not, there was a lot more pessimism then than there is now. The HSNSI fell to minus 24.4% in December 2018, versus a positive 3.1% early Monday. This 24.4 percentage point difference is a good indication of how much less pessimistic (i.e., more positive) the average market timer is today than then.
This difference is even starker among market timers who focus on the Nasdaq stock market in particular (as measured by the Hulbert Nasdaq Newsletter Sentiment Index, or HNNSI). At its December 2018 low, the HNNSI fell to minus 72.2%. Early Monday, in contrast, it stood at minus 16.7% — 55.5 percentage points higher.
To be sure, as the chart also shows, the market timers in recent days have aggressively cut back their exposure levels. Just a month ago, for example, the HSNSI stood at 67.1%, 64 percentage points higher than on Monday. The HNNSI a month ago got as high as 82.4%, 99.1 percentage points higher than where it stands today. And with days like Monday of this week, in which the Dow Jones Industrial Average DJIA, -8.011% was down more than 2,000 points early in the session, the remaining stubbornly-bullish market timers might finally be ready to throw in the towel.
But the last few weeks teach us the perils of jumping the gun in anticipating when that might happen. Before this week, the Dow fall by 750 points or more on four separate recent trading sessions, and on each of them some of the market timers I track confidently asserted that such a drop would set up the sentiment foundation for a rally.
The sign of a contrarian bottom will be when few will be so eager to declare that a bottom is at hand. A bottom comes when all hope is lost.
But this time is different
One comeback to this argument is that contrarian analysis doesn’t apply in situations like now, where we have not just one, but two, Black Swan events hitting the market simultaneously: The Covid-19 pandemic and the Saudi Arabian-led oil price war.
This comeback betrays a misunderstanding of contrarian analysis. Though no two market declines are the same, human nature remains constant. Contrarian analysis keys off the consequences of that human nature, not the particulars of why investors are becoming more or less pessimistic.
Just think back to the Sept. 11 terrorist attacks, which certainly was historically unique. And yet contrarians correctly concluded that the extreme pessimism in the wake of that tragedy was a good buying opportunity.
As I asked rhetorically a week ago, what did you think the Baron Rothschild (perhaps the investment arena’s most famous contrarian) meant when he said the time to buy is when the “blood is running in the streets?” It does none of us any good to be a fair weather contrarian but then lose faith the moment things start looking dicey.
Indeed, as I also pointed out a week ago…
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