A contrarian case can be made that the stock market rally since the October lows is the beginning of a new bull market. That’s because the criteria for “capitulation” that I laid out in previous columns have been met.
Capitulation occurs when investors give up because of despair, the last emotional stage of bear market grief. Without it, the odds are considerable that any rally is but a blip. When I last devoted a column to a contrarian analysis of stock market sentiment two months ago, capitulation had not yet occurred. That has changed. To review, the capitulation indicator keys off the two sentiment indices my firm calculates. The first reflects the average recommended equity exposure level among short-term timers who focus on the broad market, as represented by benchmarks such as the S&P 500
and the Dow Jones Industrial Average
The second covers 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 over the trailing month in which each of these two indices is in the bottom decile of its historical distribution since 2000. At many major market bottoms of the past, this indicator rose to 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 point of view, is the restraint that market timers have shown in the face of the DJIA’s greater-than-20% rally since its low two months ago. One of the telltale contrarian signs of a bear market rally is an eagerness to jump on the bullish bandwagon. The prevailing sentiment at the beginning of a new bull market, in contrast, is stubbornly held skepticism. There is considerable evidence of this stubbornness. Consider the Hulbert Stock Newsletter Sentiment Index (HSNSI). In the face of the DJIA’s rally of more than 20%, the HSNSI has risen only modestly. It currently stands at the 35th percentile of its historical distribution, as you can see from the chart at the bottom of this column. That means that 65% of the daily HSNSI readings over the past two decades were higher than where it stands today. We would normally expect a 20%-plus rally to cause many more market timers to turn bullish. It’s remarkable tha …