Put-Call Ratio Shows U.S. Stocks Are Poised To Fall

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September 11, 2013 4:07pm NYSE:DIA NYSE:SPY

bearbullDouglas Davenport: One of the most important stock-market indicators, the put/call ratio, whose indexes are shown in the charts below, is at ultra-low levels, signaling the U.S. stock market is about to make a dramatic move lower.

That gauge is saying, in so many words, that investors are complacent and worry-free; they think that nothing can go wrong and that stocks can rise forever. The S&P 500 Index yesterday climbed for the sixth straight day, meaning it’s increased every trading day this month. (When there are few “put” options on stocks, investors believe stocks will rise. And it’s the reverse with “call” options.)

Part of the problem is that investors are seeing a rosy world through the Fed’s glasses. The Federal Reserve a week from today will reveal the results of its policy meeting, and most investors predict the central bank will reduce, or “taper,” in Fed speak, its $85-billion-a-month bond-buying program. The Fed would only do so, according to Chairman Ben Bernanke, if the economy showed sustainable gains.

What would happen if stocks start to tank before the central bank’s meeting? As we’ve seen since the financial crisis struck five years ago, sentiment can change as fast as a flickering light. And we know that the Fed’s Treasury purchases have propped up the stock market, creating bubbles in several asset classes. What its quantitative-easing program has done for the economy is a different story; many economists say the $3 trillion-plus in stimulus money has created few jobs.

The last time the put/call ratio was this low was a year ago, when the S&P 500 dropped over 130 points. Fair warning: A stock-market sell-off could start any time over the coming days. The big push higher yesterday —  and the five days before that — may have more support, and bulls would like to fill the S&P 500′s 1,680-1,685 gap. That could be the last hurrah.

My Weiss colleague, Bill Hall today argues in his column that the S&P 500 has peaked for the year. He cites seven reasons, among them weakness in emerging markets and “structural” obstacles that hobble the U.S. economy.

Bill writes: “I don’t expect a major stock-market correction, which I would define as a drop of 25 percent or more. But I do anticipate that at some point between now and Thanksgiving, equities will have fallen 10 percent to 15 percent.”

Keep in mind that he correctly predicted the run-up in stocks in the first half of the year.

Anyway, the next few weeks will be interesting for investors, especially with the Fed meeting next week. Despite jitteriness because of a possible U.S. attack on Syria, investors’ optimism is high, and they think this long-in-the-tooth rally can extend itself. But I’ve learned that when sentiment is at the poles, an abrupt change is bound to take place.

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Doug-DavenportThis article is brought to you courtesy of Douglas Davenport

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