By Mark Hulbert
The stock market’s low for the year on the last day in September is likely to be breached in this bear market, according to a contrarian analysis of market timer sentiment.
That’s because at no point in this bear market has there been the thorough-going pessimism and despair that often accompanies major bottoms — what many refer to as capitulation, or throwing in the towel.
We’ve come close, however, so a strong bear market rally is not unexpected. The benchmark S&P 500 Index /zigman2/quotes/210599714/realtime SPX +0.38% and the Nasdaq Composite Index /zigman2/quotes/210598365/realtime COMP -0.23% are in a bear market, defined as a decline of at least 20%.
Consider the definition of capitulation that I have employed in previous columns on this subject: The percentage of trading days over the trailing month in which both of my firm’s stock market sentiment indices are in the bottom deciles of their historical distributions. Those two indices are the Hulbert Stock Newsletter Sentiment Index, which reflects the average recommended equity exposure level among market timers who focus on the broad stock market, and the Hulbert Nasdaq Newsletter Sentiment Index, which reflects the exposure level among Nasdaq-focused timers.
This capitulation metric currently stands at 57.1%, as you can see from the accompanying chart, below. That’s no higher than what it rose to in the days leading up to the June bottom, and still well shy of the above-80% readings it reached at major market bottoms of the past two decades.
The optimists among you may try to hang your hat on the potentially bullish contrast between the current reading and the highest it reached in March 2020, at the bottom of the waterfall decline that accompanied the initial lockdown of the Covid-19 pandemic. It got no higher than 42.9% during that bear market.
I wouldn’t, however, make too much of this contrast. The early-2020 bear market was extraordinarily short, barely lasting longer than a month from start to finish. In order for this capitulation metric to rise above 80%, therefore, my firm’s stock market sentiment indices would have had to drop into their bottom deciles almost from the very beginning of that bear market — which is unheard of within just a day or two of an all-time bull market high.
Even though I judge recent market timer sentiment to have fallen short of true capitulation, it’s still true that the timers as a group have become quite bearish — which is bullish from a contrarian point of view. My capitulation metric currently stands at the 98 percentile of all daily readings since 2000, which means it’s gotten higher just 2% of the time. That percentile reading may very well be high enough to support a sizeable rally.
Hayes Martin agrees. Martin, president of the advisory firm Market Extremes, is one of the few market experts to whom I often turn to for insight. In an email, Martin said: “There is sufficient pessimism to support a good reflex bounce. But capitulation has not yet appeared. Many sentiment gauges are in the ‘close but no cigar’ category.”
What about market timers in other arenas?
The stock market is just one of the arenas in which my firm tracks market timers’ average exposure levels. Besides the Hulbert Stock Newsletter Sentiment Index and the Hulbert Nasdaq Newsletter Sentiment Index, my firm also constructs comparable indices that focus on the gold and the U.S. bond markets.
The chart below summarizes where the timers currently stand in all these arenas.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at firstname.lastname@example.org .