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Looks and smells like bear market rally

Nov. 4, 2011, 12:01 a.m. EDT

Looks and smells like bear market rally
Commentary: Contrarians believe Oct. 4 lows will be broken
By Mark Hulbert, MarketWatch

CHAPEL HILL, N.C. (MarketWatch) — If it looks like a bear market rally, and smells like a bear market rally, then?

It’s been exactly one month since the S&P 500 (SNC:SPX) dipped into official bear market territory. In the wake of the 17% rally since the Oct. 4 intra-day low, advisers have been falling over themselves retreating from the bearish camp and jumping back on to the bullish bandwagon.

That kind of behavior suggests that what we’re seeing is a bear market rally.

I noted this disturbing sentiment trend one week ago, on the day of what so far has been the high for the month-old rally. Unfortunately, developments on the sentiment front since then paint an even more disturbing picture. ( Read my Oct. 28 column, entitled “Wall of worry gives way to slope of hope” )

Consider the average recommended equity exposure level among a subset of the short-term stock market timers tracked by the Hulbert Financial Digest (as measured by the Hulbert Stock Newsletter Sentiment Index, or HSNSI). Even though the stock market is lower today than where it stood one week ago, this average has continued to grow.

This suggests a stubbornly held optimism on the part of the average market timer, which is a dangerous condition, according to contrarian analysis.

The HSNSI is now 51 percentage points higher than where it stood a month ago. To put that in context, consider that over the first month of the last six bear markets, the HSNSI never grew by that much. In fact, the average increase in this sentiment index over each of those six bear markets’ first month was just 19.9 percentage points.

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