When Bad Is Good

¹²When Bad Is Good
Sentiment Is Now Gloomy Enough To Support A Rally

By Mark Hulbert, Marketwatch | 28 August 2010

CHAPEL HILL, N.C. (MarketWatch)— From a sentiment perspective, the Dow's dropping below the 10,000 level appears to be the straw that broke the camel's back. And that's good news: It puts contrarian analysis back solidly on the side of the bulls. When I last devoted a column to stock market sentiment, at the beginning of August, I reported that the veritable "wall of worry" that a bull market likes to climb had weakened considerably. I concluded by saying that the fate of July's rally would depend on whether sentiment quickly dropped back into the pessimism category. (Read my Aug. 3 column.)

Not only did this drop in sentiment never materialize, but advisers continued to become even more bullish in the sessions following that column. From a contrarian point of view, therefore, recent market weakness has not come as a complete surprise. Fortunately, however, in recent sessions many advisers have thrown in the towel.

Consider the average recommended domestic equity exposure among a subset of short-term stock market timers tracked by the Hulbert Financial Digest (as measured by the Hulbert Stock Newsletter Sentiment Index, or HSNSI). This average currently stands at minus 6.6%, which means that the average short-term stock market timer is actually recommending that his clients allocate 7% of their equity portfolios to shorting stocks.

In early August, in contrast, when advisers were 'insufficiently' worried, the HSNSI stood at 35%. A week after my early-August column, furthermore, the HSNSI got as high as 47.5%. This means that the average recommended equity exposure has dropped more than 54 percentage points in a little more than two weeks' time. That should be enough pessimism to support a rally.

In addition, market timers who focus on the Nasdaq market in particular— and who tend to be an especially volatile bunch— are even more bearish right now. Their average exposure now stands at minus 50%, which means that they're now allocating half their equity portfolios to an aggressive bet that the market will continue declining. They may turn out to be right, of course.

But, historically, market timers on average have been wrong more often than they've been right. I acknowledge that it's not comfortable to step up to the plate when the stock market is acting as dismally as it is right now. But, to quote Nathan Rothschild's famous phrase, the time to buy is when the blood is running in the streets— and that's not easy to do, to say the least.

Also, don't forget that you will be perennially late if you wait to invest until it feels easy or comfortable to do so. Just think back to early August, when the Dow Jones Industrial Average (DJIA 10,151, +164.84, +1.65%) was trading at the 10,700 level and things felt a lot better.

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Normxxx    
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