There has been an even bigger surge in optimism — and that’s not good

The market likes to climb a so-called Wall of Worry, and the wall that existed as recently as a couple of weeks ago is now crumbling.

The stock market’s near-record-setting rally over the past month may soon peter out, according to a contrarian analysis of investor sentiment.

That’s because alongside the market’s rally there has been an even bigger surge in optimism. Many on Wall Street are behaving as though the worst of the tariff-induced market volatility is now behind us. That’s a bad omen from a contrarian point of view, since the market likes to climb a so-called Wall of Worry — and the wall that existed as recently as a couple of weeks ago is now crumbling.

The normal pattern is for investors to be more cautious rather than less cautious after the market completes a round trip through a correction. That’s because the correction makes investors even more aware than they were previously about the risks they face in the stock market. So even when the market makes it back to where it was before the correction, the typical investor is more wary.

Not this time, however. The roundtrip from the stock market’s tariff tizzy was completed last Friday, May 2, when the S&P 500 closed higher than where it had been on April 2 before President Donald Trump imposed his “liberation day” tariffs. And yet Wall Street’s mood is significantly more upbeat today than it was then.

Consider the average recommended equity-exposure level among several dozen short-term stock-market timers monitored by my performance-auditing firm. (This average is what’s reflected in the Hulbert Stock Newsletter Sentiment Index, or HSNSI.) This average was 25 percentage points higher on May 2 than on April 2.

An even bigger increase was registered among short-term market timers who focus on the Nasdaq in particular. This average (the Hulbert Nasdaq Newsletter Sentiment Index, or HNNSI, in the accompanying chart) was 64 percentage points higher on May 2 than on April 2.

Another illustration of this surge in optimism comes from CNN’s Fear and Greed Index, which measures where CNN’s read of market sentiment stands relative to its history on the fear-versus-greed spectrum. Higher readings indicate less fear and more greed, and on May 2 this index was 35 percentage points higher than on April 2. In fact, it is even higher today than where it stood on Feb. 19, the day of the S&P 500’s all-time high.

If this were the beginning of a new bull-market leg that could take the broad market indexes to new all-times highs, then we’d expect that the past three weeks’ rally would have been met by more skepticism. Since it hasn’t, contrarians expect that the rally will soon lose steam.

That doesn’t necessarily mean that a bear market is imminent. One possible scenario is that the market pulls back into correction (but not bear market) territory and the mood on Wall Street sours considerably. The Wall of Worry that thereby gets built might then be strong enough to support a push to new highs.

Contrarians prefer not to speculate, however, letting the market tell its story in its own time. And for now, the moral of that story is that caution is a virtue.

What about market timers in other arenas?

In addition to the HSNSI and the HNNSI, my firm also calculates two other sentiment indexes: One for the gold market, and a second for the U.S. bond market. The chart below summarizes where all four sentiment indexes currently stand relative to their histories.