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Friday, 30 April 2010

Extraordinary Bullishness

by Mark Hulbert

Commentary: Nasdaq timers now most bullish in nearly a decade

These are times that try contrarians' souls.

Maddeningly, it's unclear whether the mood out there is too positive (which would be bearish), or too negative (which would be bullish).

On the one hand, individual investors remain profoundly skeptical of the stock market. Domestic equity mutual funds, for example, over the last year have actually suffered a net outflow. That's extraordinary, since the usual pattern is for investors to pour huge amounts of new money into the stock market in the wake of rallies as strong as the one we've experienced over the last year.

Furthermore, according to the latest data for April, there is no sign that this trend is about to change.

On the other hand, investment advisers are bullish right now -- more bullish, in fact, at least by some measures, than they have been in a decade.

Since I devoted a column earlier this week to discussing the mutual-fund flow data, I'm focusing this column on the data showing the mood to be too optimistic.

Consider the Hulbert Nasdaq Newsletter Sentiment Index (HNNSI), which represents the average recommended stock market exposure among a subset of short-term Nasdaq market timers tracked by the Hulbert Financial Digest. This is a useful sentiment measure on which to focus, since the Nasdaq market is one in which sentiment plays a particularly large role (remember the Internet bubble)?

The HNNSI's latest level, at 80%, is dangerously high.

To put this current level of bullishness into perspective, consider that the HNNSI as recently as early February -- at the depths of the January-February stock market correction -- stood at minus 16.1%, or 96 percentage points below where it is today. That represents an extraordinary swing in sentiment for just 2-1/2 months.

In fact, to find another occasion on which the HNNSI was any higher than where it stands now, you have to go back to July 2000, almost 10 years ago. That earlier occasion, need I remind you, came just as the Internet bubble was unraveling and the mood was still quite giddy.

How can a contrarian resolve the inconsistent messages of the mutual-fund flow data and the investment advisory sentiment data?

One way might be to view the advisory sentiment data as having more short-term significance. This helps to make sense of the data, since the mutual-fund flow numbers have painted a largely consistent picture over the last 12 months of investor skepticism, while the sentiment measures based on investment advisers have fluctuated widely -- on the whole, reaching peaks of optimism before the market fell, and reaching troughs of despair before the market rose.

What might this mean for interpreting the sentiment data today? Given the profound skepticism towards the rally among fund investors, the bull market should be given the benefit of the doubt.

However, given the extreme optimism among investment advisers, the odds of a short-term correction are now dangerously high.
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