Don’t get carried away by rising stocks By Mark Hulbert
* November 21, 2014
Euphoria has set in, and investors will be in for a rude awakening
CHAPEL HILL, N.C. (MarketWatch) — Bullish enthusiasm for stocks, which has jumped enormously over the past month, is likely to continue for a while longer.
That is good news from a short-term perspective, since cash coming from the sidelines could very well keep the equity market’s recent rally going until the new year.
But it’s bad in the long term, according to contrarian analysis, since there already is a lot of euphoria on Wall Street. If the prevailing mood becomes even more bullish, we soon could be facing a situation of such extreme bullishness that a major decline becomes likely.
Consider the average recommended equity exposure level among a subset of short-term stock market timers tracked by the Hulbert Financial Digest (as represented by the Hulbert Stock Newsletter Sentiment Index, or HSNSI). On average since 1990, the HSNSI in December has been the highest of any month.
Across all 12 months, the HSNSI’s historical average has been 41.9%. December’s average level has been 50.4%, nearly 9 percentage points higher. This difference is highly significant at the 95% confidence level that statisticians often use to determine whether a pattern is genuine.
As you can see from the accompanying chart, January is the only other month that comes close to December in the euphoria department. The average HSNSI level during the first month of the calendar is only 3 basis points lower than December’s, which counts as a statistical dead heat.
The reason this seasonal pattern is short-term bullish: Some of the cash currently on the sidelines is likely to be put back into the stock market in coming weeks. Other things being equal, of course, that would be good for stocks.
The reason this pattern is longer-term bearish: As contrarian analysis teaches us, the market does not accommodate extremes in sentiment for very long. And we’re already close to a bullish extreme now, even before an expected December-January boost.
For example, the HSNSI currently stands at an already high 63.7%, higher than 82% of all daily readings over the past 25 years. If the HSNSI follows the seasonal patterns and grows over the next two months, we could soon be facing a level of irrational exuberance that exceeds even the extremes of the go-go years of the late 1990s and early 2000 — immediately prior to the bursting of the Internet bubble.
The bottom line: By all means, celebrate the holidays. But don’t let holiday cheer influence your opinion of stocks’ prospects.
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