Bearish Sentiment

By Guest Contributors on May 26, 2010

Looks like the bears are beginning to come out of hibernation again.  Beginning with the Goldman Sachs fiasco, followed by continuing uncertainty about the viability of the Euro as Greece debt hits the wall, equity traders have begun to head for the exits.

The CBOE Put/Call ratio is a contrarian indicator gauging the sentiment in the market.  Basically, it measures the number of traded put options in a given day against the number of call options.

The chart to the right (Figure 1) illustrates the current ratio at 1.3 (meaning 1.3 puts for every call) which is the highest
level seen in quite some time – in fact, as the next chart
(Figure 2) illustrates,  the last time the ratio was this high was in March 2008, the first drop of the SP500 prior to the complete collapse in June 2008.

The more actively followed VIX index shows increased volatility in the market which directly correlates to falling prices.  Similar to the put/call ratio, the VIX index measures the implied volatility of SP500 index options – the higher the volatility, the costlier the options.  Accordingly, as the last chart (Figure 3) illustrates, when the VIC rises, the market falls.

Clearly, market sentiment is negative.  In our 2010 first quarter
report, we established that markets had risen far too quickly
from the 2009 low given the underlying rate of earnings growth.   We expected a pullback based on valuation to “normalized” valuation levels, but expected continued growth through 2011.  But not without significant volatility.

Short term, market participants should recognize this will increase volatility and exacerbate price swings.  The European monetary problems, escalating US debt and continued visibility of all that continues to be wrong with the financial alchemy in the US brokerage industry will weaken investor resolve.