Market Recovery Continues, but Few Believe in It

Includes: DIA, QQQ, SPY
by: Babak

I’ve been yammering on about market bottoms, bullish indicators and contrarian sentiment and other similar ideas for some time. The only thing I haven’t done is reach through the monitor and slap you around till you get some long exposure.

Yesterday money flowed into advancing stocks to a staggering degree. As measured by volume, advancing issues were 3.5 times the declining ones on the NYSE and 8.3 times on the Nasdaq. That’s short of the sort of stampede that gives us the rare and valuable 90-90 days but there was no question buyers were in control.

Tuesday’s market action was similar although much more muted. Coupled with Monday’s hammer candlestick, we now have 3 consecutive up days. It would seem (if I may count my chickens before they hatch) that we are having a successful retest of the mid January lows above the 1320 S&P 500 level.

You’d think that in a such a scenario people would be bullish, or at least a bit excited, right?

Turns out that while the market has been going higher, people are actually not excited at all. In fact, they’re slightly more bearish! Check out this chart comparing the S&P 500 index (candlestick) with the CBOE equity only put call ratio (line):

click to enlarge

Take Tuesday as an example. While the S&P 500 reached 1360 and managed to close up 0.93%, the CBOE equity only put call ratio went from 0.68 to 0.78 - meaning that people bought more puts than the previous day. Also, the ISEE Index dropped from 115 to 82 - meaning that people bought less calls than the previous day.

Yesterday the market went up another ~1% and we had the CBOE put call ratio drop ever so slightly (almost unchanged) and the ISEE Index dropped again, from 82 to 72. That’s equally as pessimistic as February 5th, when the market fell 3.2% in one day!

Of course, the usual and expected pattern is for option traders to buy calls when the market goes up, and to escape into the shelter of puts when it goes down. The opposite happens from time to time, and I don’t want to read too much into just two day’s worth of data but nevertheless, it is noteworthy.

It would be very normal for the market to pause and digest this short term move up, but the negative sentiment is undeniable. And it is congruent with other things I’m seeing. For example, most of the email I get is about how we are about to fall again and how the “bulls are going to get slaughtered”, etc.

The market can be a sadistic vixen, exerting maximum pain on the maximum number of people. That’s when it pays to be in the minority.