The end of the bear market is not close. That’s according to a contrarian analysis of stock market sentiment: the U.S. stock market hasn’t yet experienced the extreme pessimism seen at major bottoms.
It may certainly feel like there’s plenty of pessimism and despair on Wall Street. But that bearishness seems a mile wide and an inch deep. My sentiment indices, based on market timers’ recommended equity exposures, continue to indicate an underlying eagerness to declare that a bottom has been formed.
Of course, the stock market could stage a sizeable rally at any time. But the analysis suggests that any upside would probably not amount to more than a bear-market rally.
I base these conclusions on the failure of the two stock-market sentiment indices my firm maintains to not only drop into their respective zones of extreme pessimism (the bottom 10% of their historical distributions) but to stay there for more than a day or two. These two indices — the Hulbert Stock Newsletter Sentiment Index (HSNSI) and the Hulbert Nasdaq Newsletter Sentiment Index (HNNSI) — reflect the average recommended equity exposure level among a particular subset of short-term stock market timers.
I’ve written before about these indices’ failure to remain within the bottom deciles of their distributions. The metric I have proposed is the number of trading days over the trailing month in which both indices stay in their bottom deciles. This currently stands at 23.8%, well-short of the levels to which this percentage rose on the occasion of prior market bottoms. For example, at the bottom of the 2007-09 bear market that accompanied the Global Financial Crisis, the comparable total was 81.0%.
A similar conclusion comes from the absence of what technical analysts refer to as “capitulation.” Investopedia defines this as “the dramatic surge of selling pressure… that marks a mass surrender by investors.” While analysts define capitulation differently, none of those I follow believe that capitulation has yet occurred.
One such analyst is Manuel Blay, editor of TheDowTheory.com, an advisory service founded by Jack Schannep. Though their particular criteria for capitulation are proprietary, their website indicates that they are based on a “Short-term Oscillator which measures the percent of divergence between the three major stock market indices (Dow Jones Industrial Average
Standard & Poor’s 500
and the New York Stock Exchange Composite) and their ten-week, time-weighted moving averages.”
The required levels change each week. But for now, Blay said in an email, it would require at least two of the three market averages to close below these levels: Dow below 28,407; S&P 500 below 3,553; and the NYSE Composite below 13,532. Each of these market benchmarks currently are several percentage points higher.
Another technical analyst who is waiting for capitulation to signal the end of the bear market is Sam Stovall, chief investment strategist at CFRA Research. In an email to clients this week, Stovall said that he bases his definition of capitulation on a “15-day average of daily percent differences between intra-day highs and lows for the S&P 500.” Capitulation is indicated “when spikes [are] well above two standard deviations.”
In an email, Stovall wrote that the market currently “is above 1 standard deviation, but below two standard deviations, implying we have further to fall.”
(Full disclosure: Neither TheDowTheory.com nor CFRA Research/Stovall are among the advisers who contract with my auditing firm to track their returns.)
The absence of capitulation doesn’t guarantee that the bear market has further to go, I hasten to add. Blay points out that, while capitulation is a reliable indicator the bear market is coming to an end, not all bear markets end with capitulation. No indicator is perfect, after all.
Still, history teaches us that this bear market will most likely end in capitulation. So be on the lookout for a selling climax, as evidenced by extreme bearishness among market timers, spikes in volatility, and big drops in the market averages. If such a climax occurs, contrarian investors would sit up and take notice.
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
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