Put/Call & Margin debt ratios sends out yet another warning sign to the bulls…

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3 mins. to read


Following one of the worst financial crises the word has seen since 1929, the rebound that the US equity markets in particular have seen from the devils number itself – 666 in March 2009 has been pretty impressive. In fact, the current bull market looks to be on course to be one of the strongest in history – testimony indeed to the power of money printing! Go Yellanke go!!

As we now close on the fifth year of the stock run, it seems retail investors have finally returned to the market. Sadly this is after it has nearly tripled and pretty much every signal there is out there tells you that returns hereon out, barring a hyperinflationary scenario (in which nominal returns are meaningless), are likely to be very muted at best and at worst, possibly disastrous. Just what is it that makes retail investors collectively sell at lows and buy at highs?

It seems that retail investors are often misled by the binary emotions of greed & fear and which are alighted upon with vigour by the worst of the investment community who will have you buy at a high and sell at low without a second thought as long as they are receiving their commission… Collectively, investors are hard wired to pursue active trading strategies that put them squarely in the front line of the battlefield that is the market. Figures that we revealed her earlier this week (see below) in which margin debt has reached new peaks in the US of over $400bn is very worrisome indeed. The very vast majority of this will be long (retail doesn’t do short) and so should there be a real correction (looong overdue), the selling will simply be amplified to the downside.

In looking at the options activity in the last 2 weeks post the “token taper” announcement of a measly $10bn at the last fed meeting, it seems that investors are not positioned for a downdraft too. The equity only Put:Call ratio, as shown below over the last 2 ½ years, is particularly illustrative of this fact. I really like this measure and although it works best finding bottoms, the current weekly figure of 0.46 has coincided with market peaks before – and with a high degree of accuracy. I have circled the chart to show where the 3 week ema was previously of a similar measure as currently. The weekly ema is a better reflection of the “collective” bullish sentiment rather than one singular days print. Reason for this is that it weights recent price moves and averages on a 3 weekly rolling basis.

Put Call ratio

As we can see it has not been lower for nearly 3 years and the last time it was in fact as low as during April 2010, Jan 2011 and briefly in May 2011 (you can check the figures here – http://www.cboe.com/data/PutCallRatio.aspx). To make it easy for you I have highlighted these occasions on the chart of the S&P 500 below over the last 4 years.

S&P 500 4 year chart

Notice anything? The measures from the options market when the ratio was where we currently are now coincided with pretty sharp pullbacks of around 7 – 20% in the index. What also stands out to me is the deviation from the 37 week ema of the index at the time of the same measure – around 10%. Where are we now? Around 9%… 10% would be 1870 on the S&P. 

Unfortunately, timing the market isn’t easy. There are so many variables influencing equity prices that no one can be sure about the right time to enter and to leave. But one thing is for sure, a bull market doesn’t last forever. Some simple statistics are revealing – a typical bull market lasts 3.5 years on average and with the current bull market being on the cusp of its 5th anniversary, the trend may not in fact be your friend.

I leave you with a priceless comment from one of the bulletin boards and that very likely might go down as the signifier of the top!

“It’s easy. Just go long. The market can’t go down. I’ve nearly paid off my mortgage!” Likely famous last words…

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