A Figment of the Bulls' Imagination

Apart from their reliance on misleading or bogus statistics and a complete misreading of recent geopolitical developments, one argument the equity bulls keep making is that prices are "climbing a wall of worry."

In other words, because there are too many bears, the stock market can't -- or won't go down.

In principle, I agree with the concept, and it is one of the reasons why I stated publicly last March that I expected share prices to stage a decent bounce. Anybody who has every studied the history of markets, including during the Great Depression, knows that markets rarely go in a straight line -- up or down.

Regardless, it appears that the so-called surplus of bears is a figment of the bulls' imagination. As with all of the other delusions the bulls have been kidding themselves with lately, the facts seem to suggest otherwise, as the founder of the Hulbert Financial Digest notes in a MarketWatch commentary, "'Never Seen Anything Like It'":

Commentary: Wall Street is far more upbeat than the typical consumer

"The disparity between hope on Wall Street and malaise on Main Street continues. I have never seen anything like it."

So wrote Ned Davis earlier this week. Davis, of course, is President and Senior Investment Strategist at Ned Davis Research, a quantitative research firm that caters to institutional investors.

Just consider the disparity. On the one hand, Wall Street is positively upbeat. On the other hand, Main Street's malaise is so thick you could cut it with the proverbial knife. Consumer confidence, for example, dropped in February to its lowest level since the early 1980s.

And mutual fund investors continue to be overwhelmingly skeptical of the bull market, having pulled more money out of stock funds over the last year than new money they put in.

This dichotomy is giving contrarians fits. Is the mood out there too positive (which would be bearish), or is it too negative (which would be bullish)?

Based on the several hundred investment advisers I track, I'd have to say that bullish sentiment is approaching dangerously high levels. Consider the Hulbert Stock Newsletter Sentiment Index (HSNSI), which represents the average recommended stock market exposure among a subset of short term stock market timers tracked by the Hulbert Financial Digest.

It currently stands at 62.8%, up from 13.8% just one month ago. That's an awfully big jump for so short a period of time, especially considering that the Dow Jones Industrial Average rose a modest 4.4% over this period.

Also worrying is that, with but one exception, the HSNSI is now at its highest level since early 2007, more than three years ago.

That one exception, when the HSNSI was higher than it is now, came in early January, two months ago. Soon thereafter, of course, the market entered into its January-February correction, during which the Dow declined by nearly 8%.

Does the stock market face an equally large decline this time around? The answer, from a contrarian perspective: It depends on how advisers react to whatever weakness materializes.

If they quickly retreat to the exits, as they did in January and early February, odds increase that the decline will be relatively shallow. But if they more stubbornly hold on to their current bullishness in the face of any market weakness, then chances grow that the decline will turn into something more major than what can be measured in single digits.

We'll know soon enough how the sentiment picture unfolds, of course.

But, as of now, because advisers have been so quick to jump back on the bullish bandwagon, downside risk appears to be elevated.

Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980

Comments

[AnalystAnalyzer]

Definitely too bullish these days although I'm not complaining. I'm expecting a correction and then I'm just being optimistic that it'll have a bigger bounce back.

[RatherBFlying]

It's a standoff. If any of the casino professionals (Wall Street) makes a move towards the door, they all lose because there is no one to sell to. They are waiting for the amateurs (Main St.) to come back and buy! buy! buy! The market will crash only after Ma and Pa decide to throw their meager holdings back in to the market.

How long will Ma and Pa hold out?

[robert]

RatherB I'm not sure Ma and Pa (the traditional "bag-holders") have much left to throw. I think the irony of a role reversal here (Wall Street becomes the bag-holder) is too delicious to imagine. It would not be unprecedented considering the so-called smart money losses during the early 30s. Perhaps they have deluded themselves into thinking the government is going to buy from them on behalf of Ma and Pa!

On the subject of HFD forecasting I am positive there was something a week or two ago arguing the opposite of what Mr. Davis is now saying. Perhaps the change in view is due to the 13%+ increase in bullish sentiment? One thing I know is that these guys were bang on calling the gold top (so far) via news letter sentiment and should be accorded some respect.