The beginning of the end of the stock market’s correction could be near

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The end of the U.S. stock market’s correction is looking a lot closer. That’s the conclusion of a contrarian analysis of market timer sentiment. It’s encouraging, from a contrarian perspective, that the market timer community in recent days has become extremely pessimistic — as pessimistic, in fact, as it has been at prior market bottoms.

It will be crucial in coming days for the timers to remain this pessimistic in the face of any market rallies. If so, then expect a contrarian buy signal.Stubbornly-held pessimism has been largely absent up to this point, as I pointed out one month ago. That’s when I concluded my contrarian analysis of market timer sentiment by declaring that, because “the point of maximum pessimism… hasn’t been reached,” U.S. stocks “very likely will retest their early-March low and maybe even fail that test.”

The S&P 500 SPX, +1.46% currently is trading 12% below where it stood when that column was published. The Nasdaq Composite COMP, +2.68% is almost 17% lower.

I focused my month-ago column on the failure the two stock-market sentiment indices my firm maintains to not only drop into their respective zones of extreme pessimism (the bottom 10% of their historical distributions) but to stay there for more than a day or two. These two indices — the Hulbert Stock Newsletter Sentiment Index (HSNSI) and the Hulbert Nasdaq Newsletter Sentiment Index (HNNSI) — reflect the average recommended equity exposure level among a particular subset of short-term stock market timers.

One way of quantifying their failure is to measure how long both of these indices stay in the bottom deciles of their distributions. Over the month prior to my mid-April column, it was zero. It currently stands at 33%. Though that is a significant increase in pessimism, it still falls short of the levels to which this percentage rose on the occasion of prior market bottoms — as you can see in the table below.

Market bottom % of trading days over trailing month in which both the HSNSI and HNNSI are in the bottom deciles of their historical distributions
March 2020 47.6%
December 2018 85.7%
February 2016 52.4%
March 2009 81.0%
March 2003 100%
Orderly declines versus panics

It’s anyone’s guess what it will take this time to reach levels associated with bear-market lows. Contrarians tend to avoid even attempting such projections, preferring instead to let the sentiment data tell the story in real time.

It nevertheless is worth pointing out that, as a general rule, panic selling leads more quickly to extreme pessimism than orderly selling. And, for the most part, the market’s decline over the past several weeks has been closer to the “orderly selling” end of the spectrum. If this situation continues, it likely will take longer for the stubbornly held extreme pessimism typically found at market bottoms to appear.

This is illustrated by the tepid increases in recent days in the CBOE’s Volatility Index VIX, -5.76%. Even though the S&P 500 is on the verge of a semi-official bear market, and the Nasdaq Composite is at an 18-month low, the VIX remains well-below levels seen at prior bottoms. Currently under 35.0, the VIX is barely half what it was at the March 2020 bottom, for example. It’s even below where it was at the short-term bottom in March of this year. The VIX is not painting a picture of panic selling.

The bottom line? A strong “wall of worry” is being built, which should in turn enable the market to mount a meaningful rally. When this rally begins depends on when the construction of this wall is complete.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

More: The S&P 500 is on the brink of a bear market. Here’s the threshold.

Also read: This Wall Street legend has lived through every bear market since the 1950s. He says the one coming could hit the S&P 500 with a 30% loss

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