Why stocks may soon focus on a dangerous’ hope slope

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The mood has shifted from extreme pessimism to extreme optimism


Charles Hill, n.c. (MarketWatch) – the mood on Wall Street is showing tentative signs of danger.

That’s because the mood has shifted from the extreme pessimism that prevailed in late December to the extreme optimism of today. Some describe this as a “slope of hope”.

Consider the average recommended inventory risk monitored by nasdaq market timer I (measured by the Hulbert nasdaq sentiment index or HNNSI). In late December, that average was lower than it had been almost any time since I started collecting data in 2000 – minus 72.2%.

That’s why contrarians are predicting a strong late December rally

By contrast, the s&p 500 SPX, + 1.09% and nasdaq COMP, + 0.61% were up more than 20%, while the HNNSI was up 73%. That is 90 per cent higher than all comparable readings since 2000.

In other words, the chart shows that over a six-week period, this group of short-term stock market timers increased their average stock exposure by more than 140 points: far from being bearish (clients), a quarter of the three-trade portfolio was almost all bullish (it is now recommended that three-quarters of clients’ portfolios be very long).

To be sure, that doesn’t mean a pullback to December lows is imminent. Still, analysts say the trend is no longer in the right direction.

Of course, the usual qualifications apply. Reverse analysis doesn’t always work. And, even if it does, markets don’t always react immediately to adverse signals. As you can see from the chart, HNNSI, for example, hit a high last summer, about six weeks before the market started. This is longer than usual, but not unprecedented. But when the market finally succumbed to extreme optimism, the nasdaq fell more than 20 per cent.

Another qualification for the HNNSI as a contrarian indicator: it’s a very short-term time horizon that provides insight into market trends in recent months. So, contrary to the current contrarian analysis of market sentiment, stocks could enter important new market highs later this year.

However, opponents say that even if the market does hit a new high later this year, it could lower prices first.

Plan accordingly.

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