Do you really think the threat of a trade war is causing U.S. stocks to stumble? Thatâs what the headline writers would have you believe, but Iâm not buying it.
It strikes me as though mounting trade tensions have become commentatorsâ latest whipping boy, conveniently available as the after-the-fact explanation for whatever the market is already doing.
When the U.S. market tumbles, as it did Monday when the Dow Jones Industrial Average
Â fell by more than 200 points (before recovering somewhat by the close), increasing trade war worries are blamed. Look for the same to happen on Tuesday if the marketâs slide continues. If the market rises instead, any reports of easing trade tensions will undoubtedly receive credit.
In short, this is yet another illustration of what I wrote a week ago, when I argued that financial news headlines are at best useless and sometimes even dangerous.
Rather than focusing on the headlines, itâs far more helpful to focus on a contrarian analysis of market-timer sentiment. Thatâs because the stock market typically struggles whenever market timers become excessively optimistic. And by this past weekend, their optimism had reached near-record levels.
Consider the average recommended equity exposure among a subset of short-term market timers who focus on the Nasdaq
Â in particular (as measured by the Hulbert Nasdaq Newsletter Sentiment Index, or HNNSI). Since the Nasdaq responds especially quickly to changes in investor mood, and because those timers are themselves quick to shift their recommended exposure levels, the HNNSI is my most sensitive barometer of investor sentiment in the equity market.
The last time I devoted a column to market sentiment, one month ago, the HNNSI stood at 40.4%. Though that was much higher than the minus 35% reading to which the HNNSI fell on May 3, that mid-May reading was still merely in the middle of the historical distributionâ nowhere near the danger levels of excessive optimism. Since May 3, the S&P 500
Â has gained 5.7% and the Nasdaq Composite 9.3%. Since my mid-May column, these indices have gained 2.5% and 5.4%, respectively.
Unfortunately, the HNNSI going into this week stood at 87.6% â well into that danger zone of excessive optimism. In fact, the current HNNSI reading is higher than 97.5% of all other readings since 2000.
The accompanying chart shows the previous occasions over the last year and a half in which the HNNSI got anywhere near as high as it is currently. As you can see, in the wake of those similarly high past readings, the stock market almost invariably suffered a significant drop. Contrarians wouldnât be surprised if something similar happened now.
The usual qualifications apply, of course. Contrarian analysis isnât foolproof. And even when itâs right, it affords insight into only the stock marketâs near-term direction. It could be, for example, that equities will end this year much higher than where they are now. But if contrarians are right, the marketâs path to that higher year-end level will take it lower first.
For more information, including descriptions of the Hulbert Sentiment Indices, go to The Hulbert Financial Digest or email email@example.com .