No Irrational Exuberance

by Mark Hulbert

Most advisers continue to doubt rally, which is a good sign

There continues to be a strong wall of worry for the market to climb.

Consider the average recommended domestic equity exposure among a subset of the shortest-term stock market timers monitored by the Hulbert Financial Digest (as measured by the Hulbert Stock Newsletter Sentiment Index, or HSNSI). This average currently stands at 22.1%, which means that the average short-term market timer is recommending that his clients allocate more than three-quarters of their equity portfolios to cash.

This 22.1% equity allocation is surprisingly low, given the stock market's strength in recent weeks, and suggests that there is widespread skepticism towards the rally. And that's good news, on the contrarian grounds that the majority is usually wrong about the market's direction.

Early last May, for example, was the last time before now that the Dow Jones Industrial Average was trading above the 10,800 level. And yet the HSNSI then was more than double where it is today -- 51.8%.

So one way of characterizing the net effect of the stock market's gyrations since early May is that it has wrung a lot of bullish sentiment out of the market.

This reminds me of an analogy that some contrarians are fond of using: A bull market can be thought of as a bucking bronco in a rodeo, trying its darnedest to throw everyone off its back on the way to the other side of the ring. Clearly, this bull market is doing a pretty good job of doing exactly that.

To be sure, there is no guarantee that this market will continue higher, just because it has thrown a lot of over eager bulls off its back. Sentiment is not the only factor that influences the market's direction, needless to say.

And even if contrarian analysis turns out to be right in its current analysis, its bullishness is strictly short term. My statistical analysis of the HSNSI shows it to have maximum forecasting power over periods of between just one and three months. It tells you nothing about where the market will be in, say, a year's time.

But, with these qualifications firmly in mind, it is definitely good news that there is a strong wall of worry out there.