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Correct reaction
Editors' bearish turn is positive reaction to market correction.

Bearish turn is positive sign

By Mark Hulbert, CBS.MarketWatch.com
Last Update: 12:01 AM ET March 24, 2004

ANNANDALE, Va. (CBS.MW) - The stock market rally that began a year ago has now experienced its first 5 percent correction.

Yet, judging by newsletter editors' reaction to recent market weakness, you'd think that the market has suffered a shock and awe attack from the U.S. military.

But 5 percent corrections are entirely normal, even healthy, occurrences during sustained up moves. The only thing particularly unusual about this correction is that it took the market so long to get around to experiencing it.

Whatever the reasons for editors' quick bearish turn, however, contrarians are interpreting it as a positive sign. In advance of the correction, of course, no one knew whether the absence of a serious correction had seduced advisers into thinking that the stock market's only direction was up.

If that had been the case, then -- according to contrarian theory -- a much more serious correction would have been likely.

But we now know that the average newsletter editor, far from being stubbornly bullish, is actually quite skittish about this market. And that's bullish.

Consider the latest readings from the Hulbert Stock Newsletter Sentiment Index (HSNSI). This index measures the average stock market exposure among a subset of several dozen newsletters that update their advice on a daily basis.

As of Tuesday's close, the HSNSI stood at just 2.2 percent, suggesting that the average market timer tracked by the Hulbert Financial Digest has barely any equity exposure whatsoever.

As recently as late January, the HSNSI stood at 42.9 percent, or more than 40 percentage points higher.

Contrast the HSNSI's decline during the market's recent correction with its behavior at the stock market's top in March 2000, four years ago. Then the HSNSI actually rose in the wake of the market's initial decline off its highs.

That was stubborn bullishness, and entirely typical of what is witnessed at market tops.

But it is not at all what we're seeing today.

This pattern is even more evident among those market timers tracked by the Hulbert Financial Digest that focus in particular on the Nasdaq stock market. The Hulbert Nasdaq Newsletter Sentiment Index (HNNSI) reflects the average exposure to the Nasdaq market among such timers.

As of Tuesday's close, the HNNSI stood at negative 38.5 percent, indicating that the average Nasdaq timer the HFD tracks is actually net short the market. As recently as late January, this sentiment index stood at 71.4 percent.

In other words, since late January there has been a decline of nearly 110 percentage points in the average Nasdaq timer's equity exposure. That is a huge drop for such a short period of time.

In fact, the last time that either the HSNSI or the HNNSI were this low was in mid March of 2003, a little more than one year ago.

Need I remind you that those readings came just before the stock market rally took off?

Are there any flies in the ointment?

Of course. As I have written on many occasions over the past year, most recently the end of February, my reading of the sentiment data inclines me to believe that the rally that began a year ago is a bear market rally.

If that view is correct, that rally eventually will run out of steam, and the bear market that began four years ago will resume in earnest.

But it doesn't look like now is the time for that to occur. That rally seems to have more life left to it.