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Mark Hulbert
March 1, 2011, 12:01 a.m. EST
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By Mark Hulbert, MarketWatch
CHAPEL HILL, N.C. (MarketWatch) "” Last week's correction "” the biggest weekly drop for the Dow since last August "” was hardly good news for the bulls.
Nevertheless, there was a silver lining: Because of that correction, we now know that the stock market has a stronger sentiment foundation than previously thought.
Consider first how corporate insiders reacted to the correction. Prior to last week, there was no way of knowing whether their recent heavy selling was merely taking advantage of the strong market to sell some of their holdings (behavior which does not carry strong bearish significance), or instead was a collective bet that the market would soon decline in a major way.
Now we know: It was the former. Last week, in the wake of the market's decline, the insiders cut way back on the pace of their selling.
Consider a ratio of the number of shares that insiders have sold to the number they have bought, which is calculated weekly by the Vickers Weekly Insider Report, published by Argus Research. According to the latest issue of this report, published Monday, this sell-to-buy ratio improved markedly last week, to 4.16-to-1 from 6.46-to-1 the previous week. Most of this improvement was caused by a decrease in the numerator of this ratio, according to Vickers, which reflects insider selling.
To be sure, you may still be alarmed that insiders are still selling more than four shares last week for every one that they purchased. But bear in mind that it's entirely normal for insiders to sell more shares than they buy "” especially given the increasing proportion of insider compensation in recent years that has come in the form of shares.
Consider next the recent behavior of individual investors. In contrast to the insiders, who historically are more right than wrong, retail investors are more often wrong than right at market turning points.
Prior to last week, it was difficult to know whether the rising level of bullishness among individual investors was the normal human reaction to higher prices (which would not be particularly bearish), or instead meant that investors were becoming stubbornly bullish (which is the hallmark of the euphoria and exuberance that often appears at more major market tops).
Once again, it now appears as though it is the former.
Consider the latest survey from the American Association of Individual Investors (AAII). For the week through this past Thursday, the proportion of AAII members who reported that they were bullish dropped to 36.6% "” a 10-percentage-point drop from the previous week.
In fact, the AAII bullish percentage is now nearly 30 percentage points lower than where it stood near the end of last year.
Also falling was the average recommended equity exposure among the short-term stock market timers tracked by the Hulbert Financial Digest (as measured by the Hulbert Stock Newsletter Sentiment Index, or HSNSI). Among all such timers, this average fell by six percentage points for the week. And among those who focus on the Nasdaq market in particular, the average dropped by a whopping 27 percentage points.
To be sure, though these sentiment developments are positive omens, it's unclear how long is the time frame over which they can be considered bullish. When I first started tracking sentiment over a decade ago, my econometric research found that sentiment had its greatest forecasting power over a three-month horizon.
That time horizon has steadily shrunk in recent years, to the point that it's now less than a month. Indeed, one has to wonder if the bearish forecast of the previously high levels of bullishness were largely fulfilled by last week's drop. ( Read my Feb. 23 column.)
Regardless of this apparent compression of the market's reaction time, it's clear that sentiment's short-term trends need to be watched carefully. It would be a bad sign, for example, if investors and advisers quickly jump back on the bullish bandwagon "” and bullish if they continue last week's trend of increasing their cash position.
Stay tuned.
Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.
Mark Hulbert is editor of the Hulbert Financial Digest, which since 1980 has been tracking the performance of hundreds of investment advisors. The HFD became a service of MarketWatch in April 2002. In addition to being a Senior Columnist for MarketWatch, Hulbert writes a monthly column for Barron's.com and a column on investment strategies for the Journal of the American Association of Individual Investors. A frequent guest on television and radio shows, you may have seen Hulbert on CNBC, Wall Street Week, or ABC's World News This Morning. Most recently, Dow Jones and MarketWatch launched a new weekly newsletter based on Hulbert's research, entitled Hulbert on Markets: What's Working Now.
February retail sales should show signs of life, but don't get used to it. More drama is coming in March, writes Angela Moore.
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