Stock market timers have recently become extremely bearish, signaling a potential contrarian buy opportunity.
Excessive Bearishness Indicator
Among the group of stock market timers my firm monitors daily, the average recommended U.S. equity exposure has dropped into what I consider the zone of excessive bearishness. This level is in the bottom 10% of the historical distribution since 2000. Interestingly, from a contrarian perspective, excessive bearishness is actually a bullish indicator.
Sentiment Shift: From Exuberance to Bearishness
Just two months ago, in mid-July, the sentiment situation was completely different. At that time, the U.S. stock market was reaching new highs of a bull-market rally, and market timers were displaying signs of irrational exuberance. However, I cautioned against investing more money into stocks, stating that there was no "wall of worry left to climb."
Changing Sentiment Landscape
Fast forward to today, and the sentiment picture has undergone a dramatic transformation. As shown in the chart below, the S&P 500 (SPX) is now over five percent lower than when I published my previous column.
Contrarian analysis, while effective, does not claim to pinpoint the exact day of a market bottom. For instance, my July column preceded the actual day of the bull market high by a couple of weeks. Investors who took my advice to reduce stock holdings missed out on an additional two percent rise in the S&P 500 (SPX).
In conclusion, the recent surge in bearish sentiment among stock market timers could indicate a potential buying opportunity for contrarian investors. However, it's important to note that timing the market precisely is not guaranteed, as sentiment can change rapidly.
Sentiment Data Suggests the Bottom for this Correction is Close
It is possible that something similar could happen now, with the stock market continuing to fall for several more days before the correction hits its bottom. However, the sentiment data suggests that we are getting close to the bottom.
Unlikely to be the Beginning of a New Bear Market
Another implication of recent sentiment developments is that the current correction is unlikely to be the beginning of a new bear market. This is because bear market beginnings are typically met by a stubborn refusal of the bulls to turn bearish. However, this is not what we are seeing now.
From its highest level in July to its recent low, the market timers' average equity exposure level fell 92.9 percentage points. Drops as big as this in such a short period of time are more typical of bull market corrections rather than the start of a new bear market.
More: The S&P 500 is Brusing up Against 'The Mother of All Trend Lines.' What Happens Next Could Make or Break the Market.
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