Contrarian Signal Suggests U.S. Bull Market Could Continue

MarketWatch columnist Mark Hulbert wrote an article on Monday (the 3rd), stating that according to a contrarian investment analysis, the recent market weakness is not the beginning of a bear market.

The reason lies in the fact that during the volatile period in June and July, short-term market timing investors pulled out of the stock market en masse. This is the exact opposite of the typical scenario at the peak of a bull market, where investors remain stubbornly bullish.

According to the Hulbert Nasdaq Newsletter Sentiment Index (HNNSI), short-term market timing advisors focused on the Nasdaq have significantly lowered their recommended stock allocations since this summer, indicating that market sentiment has rapidly turned cautious.

Over the 40 trading days from the high on June 2 to the low on July 29, the Nasdaq Composite Index fell 9.8%. During the same period, however, the HNNSI plummeted by 84.4 percentage points. For contrarian investors, this means market timers are building a solid 'wall of worry,' and bull markets often climb along such walls.

You might think it's unsurprising that investors pulled back heavily after the market decline. After all, during the same period, the Nasdaq-100 Index—comprised of the 100 largest Nasdaq-listed companies—fell 11.3%, meeting the semi-official definition of a 'correction' of about 10%.

So isn't it natural for investors to increase their cash positions when the market falls this much?

The answer is 'no.' According to contrarian theory, if investors refuse to reduce exposure even as the market declines, it actually reflects dangerously excessive optimism. The classic example is the dot-com bubble of 2000. When the Nasdaq Composite first dropped about 10% from its March 2000 peak, market timing advisors actually increased their stock allocations. What followed is well known to market observers.

Looking back over time, comparing all instances since 2000 where the Nasdaq fell at least 9.8% over any 40-trading-day period yields a more complete conclusion. This time, the HNNSI’s 84.4-point drop exceeds the decline seen in 79% of similar historical cases. In other words, the speed at which market timers retreated this time was more dramatic than in most past correction episodes. Therefore, contrarian investors believe current market sentiment is far from stubbornly optimistic.

Based on this analysis, contrarian investors expect U.S. stocks to rebound in the short term, potentially moving toward new highs. They will closely watch how market timing advisors react during the next pullback.

If the market corrects again and these investors quickly exit stocks once more, that would effectively extend the bull market’s life, indicating that significant pessimism remains unpriced and room for further gains still exists.

But if, during the next downturn, investors remain highly optimistic and unwilling to reduce exposure, it could signal that real risks are accumulating in the market, and a deeper downturn may lie ahead.

Contrarian investors do not rush to predict the final outcome. They choose to let the market reveal the answer through real-time price action, rather than drawing premature conclusions. However, for now, they still anticipate a short-term rebound in U.S. stocks.