From Bulls To Bears

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A few days ago, Mark Hulbert wrote an interesting piece titled “The Bearish Bandwagon:”

OK, all of you who claim to be contrarian investors:

It’s time to see if you walk the walk, not just talk the talk.

Here’s how to find out: Are you about to step up to the plate and invest in the stock market?

Probably not, if you’re like most investors. Investing more in equities is the last thing you have in mind right now — especially after Friday’s triple-digit gain was wiped out by Monday’s late-day plunge. This leaves the Dow Jones Industrial Average more than a thousand points — or 9% — below its April 26 closing high.

But your reticence just goes to show how difficult it is to be a genuine contrarian. It’s one thing in the abstract to say that you’re willing to “buy when the blood is running in the streets,” and quite another to be willing to do so in practice.

And let there be no mistake: The blood is definitely running right now on Wall Street. Consider the sentiment among those market timers I monitor who focus on the Nasdaq market in particular, an arena particularly susceptible to changes in investor sentiment. The last two weeks have seen one of the biggest shifts from bullishness to bearishness among these markets timers that I have ever witnessed.

Just a couple of weeks ago, these market timers were on average recommending that their clients allocate 80% of their Nasdaq-oriented portfolios to stocks. That was the highest level for this average since 2000, and was a contrarian warning signal that trouble laid directly ahead.

Today, in contrast, the comparable average recommended exposure level is minus 45% (as measured by the Hulbert Nasdaq Newsletter Sentiment Index, or HNNSI). This negative level for the HNNSI means that these market timers on average are recommending that their clients allocate nearly half their Nasdaq-oriented portfolios to going short — an aggressive bet that the market will continue declining.

This represents an extraordinary shift away from excessive bullishness to aggressive bearishness in a remarkably short period of time. May 4 was the last day on which the HNNSI closed at 80%; this means there has been a shift of exposure of 125 percentage points in just 13 trading sessions.

This rush to jump on the bearish bandwagon is not typical of what happens at major market tops. According to contrarians, the sentiment at such tops is far more often characterized by stubborn bullishness.

Consider, for example, how the Nasdaq-oriented timers reacted in March 2000, just as the Internet bubble was bursting. During the first 10% drop by the Nasdaq Composite Index, the HNNSI actually rose — meaning that, at that time, these market timers believed the decline to be a buying opportunity.

Now that’s stubborn bullishness. And we all know what transpired next.

Today, in contrast, we are not seeing anything like the stubbornly-held bullishness that was so widespread then.

This does not guarantee that the stock market won’t keep falling, needless to say. And even if a significant rally does materialize soon, it doesn’t mean the market isn’t headed lower in coming months and years.

But it’s very rare for the advisory consensus to be right about the market’s direction.

One of the reasons for the common strong shift to bearishness could be that the advisor community could/should have learned something from the 2 bear market disasters of the past decade; at least I hope so.

After all, when you not only lose money for your clients on a big scale, but also see clients starting to walk looking for better opportunities, you better sharpen your skills or re-evaluate your approach.

Since over 95% of all advisors rely on buy and hold as the gospel, some may have made improvements by using sell stop disciplines to avoid participating in repeat market disasters. No one can be sure, but the above article seems to indicate that past bear markets must have made some kind of an impact for sentiment to change that quickly and to such an extreme.

At the same time, the ‘buying on dips’ mentality has been clobbered as well when markets retreated as severely as they did. It will be interesting to see if that pendulum swings back to the bullish camp just as quickly when the next rebound rally occurs.

Maybe it’s simply the realization that limiting losses is a good thing, especially if you handle other people’s money. The future of the market is an unknown, so when things get very volatile, a less aggressive investment stance has definitely merit, a view that has been largely forgotten in the past.

Of course, if you are aggressive, you can use this drop as a buying opportunity, but with the memories of 2008 still visible in the rearview mirror, this kind of recklessness can sure come back to haunt you.

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