The Stock Market Likes to Climb a Wall of Worry — But Now That’s Crumbling

The recent rally in the U.S. stock market appears to be a counter-trend advance within a longer-term downtrend. This conclusion is drawn from the analysis of Wall Street’s surprisingly bullish sentiment in recent days.

The current uptick in the U.S. stock market is likely a counter-trend rally, as indicated by the remarkably positive sentiment on Wall Street. Sustainable advances are typically met with skepticism at the outset, but this doesn’t seem to be the case this time.

A Look at Historical Reactions

To gauge the authenticity of the current market rally, it’s instructive to examine how stock market timers typically respond to a six-session rally, which corresponds to the number of trading sessions since the market’s low on October 3. During this period, the S&P 500 has gained 3.5%, while the Nasdaq Composite has risen by 4.6%.

Analyzing the reactions of market timers during previous six-day rallies of a similar magnitude over the past two decades can provide insight into how they “should” have responded to the current situation.

The behavior of market timers in the wake of the recent rally has been more bullish than historical patterns would suggest. This is particularly evident in the exposure levels of stock market timers focusing on the broader stock market, as represented by the Hulbert Stock Newsletter Sentiment Index (HSNSI).

Surging Bullish Sentiment

Since October 3, the HSNSI has surged by an astonishing 35.6 percentage points, a figure significantly exceeding the 9.8 percentage point increase historically expected in response to a 3.5% rally in the S&P 500. A similar trend is observed among equity sentiment indices that focus on Nasdaq-related market timers, represented by the Hulbert Nasdaq Newsletter Sentiment Index (HNNSI). The HNNSI has also experienced a substantial increase, climbing by 34.1 percentage points since October 3. This nearly doubles the 17.4 percentage point increase expected historically when the Nasdaq Composite gains 4.6%.

A Comparative Look at Past Bull Markets

To contextualize the current market timers’ enthusiasm, it’s valuable to compare their reactions to previous bull markets. One such comparison is the first six trading days of the bull market that began a year ago on October 12, 2022. Despite the Nasdaq Composite’s greater rise of 6.1% over a similar six-day period a year ago, the HNNSI’s increase was notably lower at 13.3 percentage points, in contrast to the recent 34.1 percentage point surge since October 3.

In light of the overwhelmingly positive sentiment among market timers, contrarian investors do not have high expectations for the current rally. The exuberance of market timers suggests that contrarian investors do not anticipate significant gains from the present rally, given the historical patterns and sentiment indicators.