Mark Hulbert: Signs of a weakening foundation

[HenryTo]

HSNSI currently at 34.5% - just a few percentage points lower than what it was in mid June. Signs of a weakening foundation, as Mr. Hulbert would argue. As for me, I would say that this is nowhere near oversold enough to sustain a good ol' stock market rally going forward.
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Signs of a weakening foundation

By Mark Hulbert, MarketWatch
Last Update: 1:24 AM ET July 5, 2005

ANNANDALE, Va. (MarketWatch) -- Here's today's contrarian factoid:

On New Year's Day, the average short-term market timing newsletter was quite bullish, while the average bond-market timing service was bearish.

Six months later, and guess what? The stock market is down for the year to date and the bond market is up. The S&P 500 index (SPX: news, chart, profile) turned in a 1% decline for the first half of the year, while the Lehman Brothers Government Bond index gained 2.4%.

It's results like these, of course, that incline contrarians to believe that they are on to something when they insist the markets rarely do what the majority expects them to.

What picture do the sentiment data paint today about the stock market?

The good news is that stock market timing newsletters are not as bullish as they were at the beginning of the year.

The bad news is that they are nowhere close to being so pessimistic as to trigger contrarian based buy signals.

Consider the latest readings from the Hulbert Stock Newsletter Sentiment Index (HSNSI), which measures the average stock market exposure among a subset of short-term market timing newsletters tracked by the Hulbert Financial Digest. It currently stands at 34.5%.

As of the beginning of the year, in contrast, the HSNSI stood at 56.1%. So to this extent the average short-term timer is less bullish today. And that's an encouraging development, from a contrarian perspective.

At the same time, however, the HSNSI still remains a lot higher than the minus 30.6% to which it fell in mid April. And that's a discouraging development.

What does this all mean?

In mid June, the last time I devoted a column to newsletter sentiment, the HSNSI stood at 39.3%, modestly higher than where it stands today. I concluded that column by saying that, from a contrarian point of view, "risk in the stock market is high and rising." (Read archived column.)

I'd place the same interpretation on the current data.

Since that mid-June column was written, the Dow Jones Industrials Average ($INDU: news, chart, profile) has dropped 275 points, or 2.6%, in just 11 trading sessions. It is indicative of the average short-term market timer's stubborn bullishness that he has reduced his exposure by just 4.8 percentage points in the face of this much of a decline.

To put his stubborn bullishness in perspective, I examined all occasions over the last three years in which, over an 11-trading-day period, the Dow fell at least 100 points but no more than the 275 points it has dropped since mid-June. On average across all such instances, the HSNSI dropped by 13 percentage points.

In other words, the typical reaction of short-term market timing newsletters has been, in the face of declines even smaller than that witnessed in recent sessions, to reduce exposure by nearly three times more than he has recently.

From a contrarian point of view, this is a worrisome sign.

To be sure, at 34.5%, the current HSNSI reading is still much lower than its record high reading of 79.7. Contrarians would be much more confident in their bearishness if the HSNSI were much closer to that all-time high.

Some contrarians might therefore be inclined just to note the developments on which I focus in this column, concluding merely that they deserve to be watched closely but do not, in and of themselves, doom the market's rally potential.

At a minimum, however, all contrarians would probably agree that the sentiment foundation of the current market is a lot weaker than what it was just three months ago.


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.