Bounce or crash, that’s the question.

Here’s the latest chart of the 5-day average equity put:call ratio. Option markets have done a lot to correct the historic extreme in complacency that we saw in April.

Indexindicators.com

Stocks are still only moderately oversold on a daily scale. RSI has made a sort of double dip into oversold territory, and MACD has also turned down to almost reach a downsloping support line formed by declines over the last 12 months. At some point this year all support should be smashed, but it would be rare to crash right from the very top. A relief rally would clear things up a lot and offer a great chance to get short.

Stockcharts.com

In contrast to the US markets, look at the extreme oversold condition in several major global stock indexes.

6-month Nikkei chart:

Bloomberg

The Eurostoxx 50 index:

Bloomberg

And here’s a 2-year view of a bunch of emerging markets ETFs. These I suppose could keep rolling over into a waterfall, but I’m not sure we’re at that stage yet.

Yahoo! Finance

Looking for a temporary bottom

World stock markets are oversold, and now that the US markets have taken a dip under the May 6 lows we have a stronger case for some near-term strength. The put:call ratio is also advising shorts not to press their luck, though there is still plenty of room on the upside, especially considering that this is indicator tends to oscillate from extreme lows to extreme highs:

Indexindicators.com

I’ve eased up on my short risk portfolio today by selling some puts, closing some ultralong ETF shorts, selling Yen and buying SPX and Nikkei futures. I’ll view any bounce as a shorting opportunity, since unlike most of the people on TV this week I don’t view this sell-off as a correction but the likely start of another leg down in a multi-year bear market.

I tend to be early on closing and easing up shorts, so take note that we don’t have much in the way of bullish action out there yet.

20-day equity put:call average at lowest level since at least 2003.

Pej at realitylenses.blogspot.com dug up the raw data and put together this chart of the 20-day average:

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The running average of the equity put:call ratio is extremely predictive of near-term market moves. It is mean reverting, and deep dips like this indicate a high degree of bullish complacency among options traders.

Complacency still extreme

Even if this is just a small correction in a continuing rally (which it is very dangerous to assume), the market has a lot of room left to shake things up. The 20-day average equity put call ratio is still at an extremely suppressed level:

Indexindicators.com

Here is the raw data since 2004, the last time we saw such a low running average of CPCE. Stocks went nowhere for about a year after that. They should be so lucky this time…

stockcharts.com

Such long-running lows must be balanced out with more than a bit of fear. One other thing that is noteable in this chart is how the Panic of ’08 only produced marginally higher put:call readings than the stagnation of ’04.

Extreme optimism and extremely low dividend yields

The 20-day average equity put:call ratio has dived to new lows, and yesterday the single-day reading printed 0.32, among the eight lowest readings since 2004.

Indexindicators.com

From stockcharts.com, here’s the raw data going back to 2004, plotted against SPX:

It looks like the closest previous instance of such a string of super-low readings (though not as many as at present) was Dec 2003 – Jan 2004, which marked the middle of the final lunge before an eight-month correction of the bull trend. Of course, that was during the fastest period of mortgage and consumer debt accumulation the US has ever seen, whereas today we are still unwinding that mess.

The markets certainly think this is 2004 and that earnings are going to explode back to the peak levels of 2007, even though it took an orgy of debt to generate those for just a few short quarters. Dividend-wise, stocks are yielding half as much as the 10-year bond, which is guaranteed to deliver those coupons, while common shareholders just hold a derivative claim.

From multpl.com, here’s the dividend yield on the SPX (and theoretical predecessor) going back to 1881 (top) vs the inflation-adjusted price (bottom). Even at the lows last year, stocks were never even close to a good deal in historical terms, and in fact their yield then was about the same as at the 1898, 1907, 1929, 1966, 1968 and 1987 market peaks:

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It’s clear from these charts that investing in a low-yielding market is not a winning strategy for capital preservation.

All-in, all over again

Ok, the 5-day trailing average put:call ratio is giving another screaming sell signal (the one in early March was the first in ages to not result in any decline, just a 2-week consolidation). History shows that ignoring these signals is extremely perilous.

Indexindicators.com

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The 20-day average must be at an all-time low, though I don’t have the long-term data available:

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There is no longer any question that today’s market conditions resemble those seen at major bull market tops. Traders, analysts and the general public are extremely optimistic about the prospects for the stock market, but with a yield of under 2% and a macro environment that is still working off the hangover from a debt binge, the likelihood of a sustained advance is very low.

I continue to hear that the market is being propped up artificially by the Plunge Protection Team or Goldman or JPM or some such combination, and while I think it is likely that parties like these do try to manipulate its direction, I doubt very much that they can have any meaningful impact. The markets are global and an expression of social forces too large and wild to control.

Central banks publicly try time and again to manipulate floating currencies, and their efforts are always futile beyond little blips (just ask the BOJ, which once threw away $30 billion trying to supress the Yen, to no effect). Besides, history shows that markets have always been irrational, since long before the PPT. The very fact that so many people blame the PPT for the market’s rise goes to show that there have been lots of bears out there, and markets don’t peak until almost all of the bears have faded away.

20 day average put:call now at 3-year low

This powerful fear guage is registering the most complacent atmosphere in at least three years, if not ever:

Indexindicators.com

Mutual fund cash levels are also at all-time record lows, and spreads on junk bonds are tighter than ever. All markets seem priced for Goldilocks perfection.

Urge to speculate not as rampant as it seems

The recovery of the US stock indexes and big new highs in the Russell 2000 and Nasdaq seem to have convinced a lot of people that we are either entering the next phase of a sustainable bull market, or about to at least crawl up another 10% before finally exhausting. I don’t see it that way. This feels to me like October 2007, when the market had smartly recovered from a hard break on the leadership of the secondaries, but the trend had been broken and stocks were strenuously overbought on extreme complacency.

This rally has mostly been a small-cap, tech stock and speculative affair. Larger stocks are not getting the same kind of bid, nor are commodities.

I have turned very short-term bearish this week on the extreme low in the equity put:call ratio. You can see here that the 10-day moving average is lower than at any point in the last three years, which at 0.51 might actually be the lowest ever (since this includes the Goldilocks spring of 2007):

Indexindicators.com

How could you possibly be long given a reading like this?

Before concluding that we are blasting off here, take a look at oil, which has gone nowhere for five months, with each advancing impulse weaker than the last, and the latest looking particularly anemic:

Stockcharts.com

Even gold and silver, which have dependably found a strong bid whenever stocks have rallied and even when they have not, have stalled out well under their fall highs:

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Silver is weaker than gold, and this measure of risk appetite (silver:gold ratio) peaked all the way back in September:

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Perhaps the greatest beneficiary of the risk impulse has been the junk credit market, which by one measure is actually showing the narrowest spreads in history over quality. This is absolutely astounding given the economic conditions, and only explainable by the notion that the investing public, twice burned by stocks in the last decade, has decided that bonds are safe, without making any distinctions among them. You can see this trend here in the ratio of the price of JNK (junk bond ETF) to LQD (investment grade bond ETF), though this chart appears to show waning momentum:

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I’m not calling for an immediate crash, but certainly at least for a smart set-back, which may in retrospect turn out to be the start of a decline to new secular bear market lows. With the credit system still clogged with bad debt at the personal, corporate and state level, the economy simply has no ground from which to launch a new phase of business growth. What we have seen for the last year is simply unsustainable government spending and an overeager investing public that still trusts Keynesian economists and bogus statistics like GDP.

We are not out of the woods. We are entering a long phase of write-downs, defaults, bankruptcies and generaly frugality. We are not going to get away this time without our Schumpeterian event.

Max sell

The put:call ratio, the best timing indicator I follow, bar none, is giving a screaming sell signal. Are there any bears left to take it?

Indexindicators.com

One sell signal to rule them all.

You know the one: the 5-day trailing average equity put:call ratio:

indexindicators.com

Retail options players almost never get significantly more complacent than this, and they virtually ALWAYS get creamed within a week or two, sometimes a little, sometimes a lot. If you did nothing in the market but buy puts or vol when the 5-day CPCE got under 2 standard deviations from its mean and sell or tighten your stop (use a conditional stop with options) when it reached 1SD you’d have a very nice trading career.

Couple this with the classic RSI signal from Friday, and I’d place the odds of a 2% further rise here at under 10%, and the odds of a 5% decline at over 80%. To be very conservative, wait a couple of days to confirm that the rise is broken, and use a stop against the highs, but I bet stocks stall here for no more than a week then fall hard. Maybe this is Oct 2007 redux. Sure smells like a big top circus. The latest EWI publication points out that the AAII survey is again at record lows — this is not as precise a timing indicator as 5-day CPCE, but it puts it in perspective: we’re looking for a major top, so any minor top like this could be the one.