The recent decline in the U.S. stock market may not indicate the beginning of a significant bear market, according to a contrarian analysis of market timer sentiment. While a pullback was anticipated given the extreme exuberance among market timers in recent months, this week’s selling pressure has forced many out of stocks, a behavior not typically observed at major market peaks.
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Analyzing Market Timer Sentiment
The Hulbert Stock Newsletter Sentiment Index (HSNSI) tracks the average recommended equity exposure among short-term stock market timers focused on the broad market. This index provides insights into prevailing market sentiment. On December 4th, the day the Dow Jones Industrial Average (DJIA) reached its all-time closing high, the HSNSI registered 92.8%, the highest daily reading since April 2000. Following the recent market plunge, the HSNSI plummeted to 37.1%, a significant 56 percentage point drop in just 10 trading days.
To contextualize this decline, we examined historical data from the beginning of the five bear markets after 2000, excluding the 2020 COVID-19-induced bear market due to its unique circumstances. Data from Ned Davis Research’s bear market calendar reveals that none of these previous bear markets witnessed such a dramatic drop in the HSNSI during the initial 10 trading sessions. The average decline was 25 percentage points, significantly less than the recent 56-point drop. This suggests the current market downturn might not be the start of a prolonged bear market. Historically, major market tops are characterized by bullish investors who perceive pullbacks as mere pauses. The current rapid shift in sentiment indicates a less stubborn bullishness, diverging from typical pre-bear market behavior.
Long-Term Concerns Remain
While the short-term outlook appears less concerning, long-term worries persist due to the exceptionally high levels of optimism seen in recent months. As illustrated in the chart above, the average HSNSI level for 2024 is the highest in the past 24 years. This sustained exuberance suggests that when a bear market does eventually arrive, it could be particularly severe. A prolonged period of lower market performance might be necessary to dispel this excessive optimism and rebuild the “Wall of Worry” that typically precedes bull market rallies.
Conclusion: A Contrarian Perspective
The sharp decline in market timer sentiment, while indicative of a market correction, might not signal the onset of a major bear market. Historical data suggests that such a rapid shift in sentiment is atypical of major market tops. However, the unprecedented levels of optimism observed earlier this year raise concerns about the potential severity of a future bear market. Investors should remain vigilant and consider both short-term and long-term market indicators.
