Opinion: There is a strong possibility that the bear market in stocks is over because investors have lost all hope

A contrarian case can be made that the stock market rally from its October lows is the start of a new bull market.

This is because the criteria for “capitulation” that I set out in the previous columns have been met.

Capitulation occurs when investors give up out of desperation, the emotional last stage of bear market pain. Without it, the odds are considerable that any rally is but a blip. The last time I devoted a column to a contrarian analysis of stock market sentiment two months ago, the capitulation hadn’t happened yet.

This has changed.

To review, the capitulation indicator clears out the two sentiment indices calculated by my company. The former reflects the average level of equity exposure recommended among short-term timers who focus on the broader market, as represented by benchmarks such as the S&P 500 SPX,
and the Dow Jones Industrial Average DJIA,
The second concerns the COMP of the Nasdaq market,
(The indices are the Hulbert Stock Newsletter Sentiment Index and the Hulbert Nasdaq Newsletter Sentiment Index.)

The capitulation indicator is based on the percentage of trading days in the trailing month that each of these two indices is in the bottom decile of its historical distribution since 2000. At several notable past market troughs, this indicator has risen above ‘80%. . In the last half of October, the indicator rose to 90.5%.

No rush to jump on the bullish bandwagon

Another encouraging sign, from a contrarian perspective, is the restraint market timers have shown in the face of the DJIA’s more than 20% rally since its low two months ago. One of the contrarian telltale signs of a bear market rally is a desire to jump on the bull bandwagon. The prevailing sentiment at the start of a new bull market, by contrast, is stubborn skepticism.

There is considerable evidence of this stubbornness. Consider the Hulbert Stock Newsletter Sentiment Index (HSNSI). As the DJIA rallied more than 20%, the HSNSI rose only modestly. It is currently located at 35th percentile of its historical distribution, as you can see from the graph at the bottom of this column. This means that 65% of daily HSNSI readings over the past two decades have been higher than they are now.

Normally we would expect a rally of more than 20% to turn many other market timers bullish. It’s extraordinary that they didn’t. To provide context, consider market timer sentiment in the gold arena following gold’s GC00,
nearly $200 jumped in the last month. While gold’s rally is just half that of the DJIA in percentage terms, the Hulbert Gold Newsletter Sentiment Index has soared to one of its highest levels in years. As you can see from the chart below, it currently sits at 94th percentile of its twenty-year distribution.

According to contrarian analysis, therefore, equities more than gold are likely to be entering a new bull market.

What about market timers in other arenas?

The chart below summarizes the current state of the four sentiment indices my firm builds on the average exposure levels of market timers. In addition to the three mentioned above, the fourth index is the Hulbert Bond Newsletter Sentiment Index, which reflects market timers’ average exposure to the US bond market.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Rating tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com.

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