Longer-term investors can benefit from the short-term panic of market timers.
The general perception that falls are buying opportunities is a sign of a large market peak.
The significant decline in the stock market on Tuesday probably did not indicate that the bull market was coming to an end. This is due to the fact that market timers did not respond to Tuesday’s crash in the same way that investors usually do in response to significant market tops: they persistently refuse to accept that the bull market is finished.
According to the Hulbert Stock Newsletter Sentiment Index, the average short-term timer that my company monitors decreased recommended stock exposure by about 20 percentage points on Tuesday. Given how long back the data goes, that is among the largest one-day HSNSI declines since 2000.
It’s useful to compare the HSNSI’s significant decline on Tuesday with its early 2000 behavior since many people think that the stock market is creating a bubble top similar to the peak of the internet bubble in March 2000. After reaching its peak on March 10, 2000, the Nasdaq Composite Index COMP fell more than 10% intraday during the next two weeks, meeting the semiofficial standard for a stock market correction. However, the HSNSI increased by 2.5 percentage points during those two weeks rather than declining.
That contrast is illuminating. The HSNSI dropped by about 20 percentage points this week instead of growing following a stock-market decline that was just one-fifth as large as in March 2000.
According to contrarian analysis, the general perception that falls represent buying opportunities is one sign of a significant market peak. Analysis of Yale University finance professor Robert Shiller’s “Buy-on-Dips Confidence Index” provides confirmation. The indicator shows the proportion of retail investors who think that the day following significant declines, the stock market will rise. The figure below illustrates how the S&P 500 SPX has fared far worse after high index levels than following low index levels.
We don’t know where the Buy-on-Dips Confidence Index is at the moment because Shiller updates it several months later. However, considering the over 20 percentage point decline in the HSNSI on Tuesday, it is most likely fairly low.
Keep in mind that this conversation is limited to the short-term outlook for the stock market. As I’ve already stated, the market is still incredibly overpriced, so it wouldn’t be shocking if the bull market ended sooner rather than later. In contrast to how market timers responded to Tuesday’s significant decline, there will be widespread incredulity if that peak, whenever it happens, follows historical standards.
