How Optimistic Is the Stock Market Rally?

Mark Hulbert MarketWatch May 20, 2011

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Mark Hulbert

May 20, 2011, 12:01 a.m. EDT

By Mark Hulbert, MarketWatch

CHAPEL HILL, N.C. (MarketWatch) "” This week has been a story of stark contrasts:

On the one hand, LinkedIn's /quotes/comstock/13*!lnkd/quotes/nls/lnkd LNKD +109.44% initial public offering was so excitedly received that it more than doubled, rekindling memories of the irrational exuberance of the late 1990s.

Yet, on the other hand, this week's Investors Intelligence sentiment survey (which is based on the market outlooks of more than 100 investment newsletters) reported the least number of bulls since last October "” when the Dow Jones Industrial Average /quotes/comstock/10w!i:dji/delayed DJIA +0.36% was around 1,500 points lower than where it is today.

/quotes/comstock/10w!i:dji/delayed DJIA 12,605.32, +45.14, +0.36%

So what is the real story here? Is there Internet-bubble-like enthusiasm out there, or is there just as much skepticism as existed when the market was a lot lower?

My hunch is that, in actual fact, we're a lot closer to excessive optimism than healthy levels of skepticism.

Consider, for example, the Investors Intelligence survey. Though the bullish percentage in that survey is now the lowest it's been in seven months, the percentage of advisers who are bearish is not correspondingly higher. Instead, what's happened is that, as advisers have left the bullish camp, they almost entirely joined the "correction" camp "” remaining long-term bullish but expecting a short-term correction.

The contrarian significance of this is quite different than if those erstwhile bulls had instead decided to join the bearish camp. In fact, many contrarians ignore the "correction" camp altogether, focusing instead on just those who are either outright bulls or outright bears "” on the theory that they are the ones with strong opinions.

As Ned Davis of Ned Davis Research pointed out to clients earlier this week, from this perspective Investors Intelligence is still reporting a very high level of bullishness. In fact, of those advisers voicing a strong opinion, 69.9% currently are bullish.

Davis went back and looked at all instances over the last 40+ years for which Investors Intelligence sentiment data exist. He found that this bullish percentage was 69% or higher just 21% of the time, and that during those periods, the stock market on average lost ground. Given that the stock market over these four-plus decades had a strong upward bias, Davis concludes that "this is not a good place to be outright bullish."

Davis' judgment that there are worrisome levels of bullishness matches what the Hulbert Financial Digest (HFD) finds from its sentiment index, which is based on the average exposure levels of the short-term market timers the HFD monitors. ( Read April 29 commentary. )

The bottom line? Once we dig below the surface, the sentiment picture is a source of contrarian concern. And this concern has grown to outright worry in the wake of the exuberance exhibited by the huge first-day return of LinkedIn's IPO.

/quotes/comstock/13*!lnkd/quotes/nls/lnkd Add LNKD to portfolio LNKD LinkedIn Corp $ 94.25 +49.25 +109.44% Volume: 30.16M May 19, 2011 4:00p var embeddedchart1253769939Chart = new EmbeddedChart('#embeddedchart1253769939', NormalChartStyleNoDecimals, 240, 80, '1dy', '5mi', null, null, null, 'US:LNKD'); jQuery.data($('#embeddedchart1253769939').get(0), 'embeddedchart', embeddedchart1253769939Chart); /quotes/comstock/10w!i:dji/delayed Add DJIA to portfolio DJIA Dow Jones Industrial Average 12,605.32 +45.14 +0.36% Volume: 158.47M May 19, 2011 4:02p var embeddedchart70394702Chart = new EmbeddedChart('#embeddedchart70394702', NormalChartStyleNoDecimals, 240, 80, '1dy', '5mi', null, null, null, 'US:DJIA'); jQuery.data($('#embeddedchart70394702').get(0), 'embeddedchart', embeddedchart70394702Chart); //$(document).ready(function() { var storywidth = $('#mainstory').width(); var maxwidth = storywidth; $('#maincontent pre').each(function (index, value) { var thiswidth = $(value).width(); if (thiswidth > maxwidth) maxwidth = thiswidth; }); var offset = maxwidth - storywidth; if (offset > 0) { var margin = 13; var blanketwidth = $('#blanket').width(); var contentwidth = $('#maincontent').width(); $('#blanket').width(blanketwidth + offset + margin); $('#maincontent').width(contentwidth + offset + margin); $('#mainstory').width(storywidth + offset + margin); } //});

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.

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About Mark Hulbert

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.

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