The beginning of the end of the stock market correction could be near

The beginning of the end of the stock market correction could be near

The end of the US stock market correction is getting much closer. This is the conclusion of a contrarian analysis of the sentiment of market timers. It is encouraging, from a contrarian perspective, that the market timer community has become extremely pessimistic in recent days – as pessimistic, in fact, as it was at prior market lows.

It will be crucial in the coming days that timekeepers remain equally pessimistic about any rebound in the market. If so, expect a contrarian buy signal. Stubborn pessimism has been largely absent so far, as I pointed out a month ago. It was at this point that I concluded my contrarian analysis of market timer sentiment by stating that because “the point of maximum pessimism…has not been reached”, the U.S. stocks “will most likely retest their early-March lows and may even fail that test.”

The S&P 500 SPX,
+2.39%
is currently trading 12% below its level at the time of this column’s publication. The Nasdaq Composite COMP,
+3.82%
is almost 17% lower.

I focused my column a month ago on the failure of the two stock sentiment indexes that my company maintains to not only fall into their respective zones of extreme pessimism (the lower 10% of their historical distributions) but to stay there more than a day or two. These two indices – the Hulbert Stock Newsletter Sentiment Index (HSNSI) and the Hulbert Nasdaq Newsletter Sentiment Index (HNNSI) – reflect the recommended average level of exposure to stocks among a particular subset of short-term stock market timers.

One way to quantify their failure is to measure how long these two indices stay in the lower deciles of their distributions. In the month before my mid-April column, it was zero. It currently stands at 33%. While this is a significant increase in pessimism, it remains below the levels that this percentage has risen to on past market lows – as you can see in the chart below.

Bottom of the market

% of trading days in the previous month in which the HSNSI and HNNSI are in the lower deciles of their historical distributions

March 2020

47.6%

December 2018

85.7%

February 2016

52.4%

March 2009

81.0%

March 2003

100%

Orderly declines versus panics

Anyone can guess what it will take that long to reach the levels associated with bear market lows. Opponents tend to avoid even attempting such projections, preferring instead to let sentiment data tell the story in real time.

However, it should be noted that, as a general rule, panic selling leads to extreme pessimism more quickly than orderly selling. And, for the most part, the market decline over the past few weeks has been closer to the “orderly sell” end of the spectrum. If this situation persists, it will probably take longer for the extreme and stubborn pessimism that is usually found at the bottom of the markets to appear.

This is illustrated by the timid increases in recent days of the CBOE’s VIX volatility index,
-9.13%.
Even though the S&P 500 is on the verge of a semi-official bear market and the Nasdaq Composite is at an 18-month low, the VIX remains well below levels seen at previous lows. Currently below 35.0, the VIX is barely half of what it was at the March 2020 low, for example. It is even below its short-term low in March this year. The VIX does not paint a panic selling picture.

The bottom line? A solid “wall of worry” is building, which should in turn allow the market to mount a meaningful rally. When this gathering begins will depend on when the construction of this wall is completed.

Mark Hulbert is a regular MarketWatch contributor. His Hulbert Ratings tracks investment newsletters that pay a fixed fee to be audited. He can be reached at mark@hulbertratings.com

After: The S&P 500 is on the verge of a bear market. Here is the threshold.

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