Muscular Investing

Mark Hulbert Sentiment Indices: Advisers Are Contrary Indicators - part 2

Brian Livingston

Brian Livingston


How does Hulbert know the weight financial advisers are recommending on the stock market and other asset classes? • He subscribes to their newsletters and websites, and then averages their percentage allocations. No, that doesn’t necessarily mean you can use their collective wisdom for market timing. When the gurus are the most bullish, the market is the most likely to fall.

Figure 1. When advisers who time the stock market are recommending some of their highest allocations — a 60% to 80% investment in equities — the Dow Jones Industrial Average actually tends to go down in the following week.


• Part 1 of this column appeared on Dec. 18, 2018.

So far, we’ve learned that financial advisers, on the whole, are unreliable predictors of the US stock market. When their recommendations are the most bullish, the Dow doesn’t go up the following week. It tends to go down! The loss is an average of 0.14% per week. (Annualized, that’s a decline of 7.28%.) So much for that expensive advice you paid for!

But how does Hulbert know this?

Figure 1, above, shows the breakdown. When Hulbert averages the advisers’s recommendations, the scores range from a bearish reading of –36 (in other words, the advisers are 36% short the market) to +82 (they are almost 100% invested in the market).

One-tenth of Hulbert’s weekly scores are readings of 60.7 and above. That’s when the advisers are the most certain that the market is going up. Remarkably, in the week immediately after the advisers are feeling the best about the market, the DJIA falls, on average. The gurus are contrary indicators!

As Hulbert himself says, his sentiment indices are even more revealing when they are “purified.” That means you interpret the readings differently when the market has been going up than when it’s been going down.

As we saw in Part 1 of this column, you can ignore “buy” signals when the DJIA is down in the past four weeks, and ignore “sell” signals when the index is up in the past four weeks. In those cases, doing the opposite of what the advisers recommended would have given you an annualized return 1.45 percentage points greater than a buy-and-hold of a DJIA index fund — a 7.86% rate of return rather than only 6.41%. Doing the reverse of what the gurus said would have helped you beat the market!

The Dow rises more often than it falls, of course. If the advisers had simply said, “The Dow will be up next month,” they would have been right 60% of the time. (Stocks outperform bonds in about 60% of all months.)

Notice on the left side of Figure 1 the two-tenths of the readings — called the two lowest deciles — when the advisers are the most bearish. At these times, the gurus are recommending that you put a maximum of only 13.9% of your cash into stocks or go short the market about –36%.

When these strong “get out of stocks” readings occur — which is about 20% of the time — the Dow actually goes up 0.34% to 0.38% in the following week, on average.

Doing the opposite when advisers are the most wrong

Unfortunately for short-term traders, extremely high and low readings like those shown in Figure 1 don’t actually make very good reverse market-timing indicators. Figure 2, shown below, helps us to see why.

 

Figure 2. The average reading of advisers’ recommendations bounces around a great deal. Will this range of measurements continue as it has before?


The signal from the advisers’ average exposure is very “noisy.” It jumps around a great deal.

In the 17 years that are covered by Figure 2, there are times when the advisers’ opinions careened 55 points in a single week. For example, the DJIA fell almost 4% in early January 2016. Within just five market days, the Hulbert Stock Sentiment Index collapsed to –29 from its previous level of +26. It looks more like the gurus are reacting to what just happened in the market rather than accurately predicting what it’s going to do next.

Figure 2 shows a red dotted line at a reading of 60.7. One-tenth of the readings are more bullish than this, recommending an exposure of more than 60.7% in stocks.

But how do you know this dividing line is stable? What if the timing gurus happen to read this column — or subscribe to the Hulbert Sentiment Indices themselves — and start becoming more cautious when they’re feeling bullish? One-tenth of the readings might then not be above 60.7 — they might be above 55 or above 50 or whatever.

You could analyze the numbers until you’re blue in the face. You’re welcome to try. It would cost you only $20 to get one month of weekly readings through a subscription to Hulbert’s email notifications. Each notice includes a spreadsheet with all of the stats going back to April 2000.

But I’m not recommending that for most investors. Not everyone can crunch numbers like the great astrophysicist Stephen Hawking — may he rest in peace. I’ve found that individual investors do best with a simple plan, holding whichever low-cost index funds promise the strongest gains (see my summary).

The main takeaway from Figures 1 and 2 is to not entrust your money to financial advisers who claim great psychic powers. We’ll see this fact underscored in Parts 3 and 4 of this column, when we reveal the gurus’ accuracy — or lack of it — in predicting the Russell 2000, bonds, and gold.

• Parts 3 and 4 appear on Dec. 25 and 27, 2018.


With great knowledge comes great responsibility.

—Brian Livingston

CEO, MuscularPortfolios.com

Send story ideas to MaxGaines “at” BrianLivingston.com

 

Brian Livingston
About the author: is a successful dot-com entrepreneur, an award-winning business and financial journalist, and the author of Muscular Portfolios: The Investing Revolution for Superior Returns with Lower Risk. He has more than two decades of experience and is now turning his attention directly on the investment industry. Based in Seattle, Livingston is now the CEO of MuscularPortfolios.com, the first website to reveal Wall Street's secret buy-and-sell signals, absolutely free. He first learned computer programming on an IBM 360 in 1968 at age 15. Learn More