Speculation vs. Seasonality
Tuesday, December 23, 2003 8:12pm EST
With both Wednesday and Friday being half-days with a high probability of pathetic volume, tonight’s comment will be abbreviated.
There were two main reasons that I stated I did not want to short new highs in the last comment, those being a display of some hesitancy on the part of traders who are normally wrong, and the positive seasonality that you’re probably completely sick of hearing about by now. The positive seasonality is still with us, and if you look at “Christmas Day Bias” (dated 12/19/02) in the Research section of the site, you will see that the S&P 500 has been up 63% of the time the day before X-Mas since 1950, with an average return of 0.30%. Those numbers were fairly consistent whether we were in an uptrend or a downtrend (defined as a rising or falling 20-day simple moving average, respectively). The day after X-Mas has been up 70% of the time, with an average return of 0.36%, though it was more consistently positive during a downtrend (up 75% of the time) than an uptrend (up 67% of the time). These are strong and consistent probabilities, but as I always say, it is usually nothing more than a breeze for or against you – seasonality alone generally isn’t enough to override other important factors.
The other reason I mentioned – hesitancy on the part of wrong-way traders – is quickly disappearing. The example I gave in the last comment was that Rydex traders were significantly more conservative on the last push to new highs than they had been during previous rallies. This was a bullish input, but it has now diminished if not disappeared entirely. Data current as of yesterday showed a relatively large $69 million shift out of the leveraged bearish funds and into the leveraged bullish funds yesterday alone. This asset transfer, and others like it in some of the other high-beta funds, caused our Beta Chase Index to spike to a reading over 5, something not seen since the very beginning of the month. I would prefer to see it spike to 10 or so before becoming too anticipatory of a short-term market decline, however. Some of our other measures are becoming extreme as well. The Bull Ratio Stochastic yesterday hit its maximum reading of 1.0 for the first time since September 19th. A maximum reading of 1.0 in this indicator has been achieved only five other times in the past three years, and the S&P 500 was lower 5 days later every time, with an average return of -2.9%.
One other item I would like to touch on is the put/call reading from yesterday. Many of you noticed the high level of the total put/call ratio, which encompasses both equity-option and index-option volume. The index portion of the put/call ratio was extremely high at 3.27, while the equity portion was muted at 0.61. Much of the reason for the high index put/call ratio can be attributed to SPX options (based on the S&P 500), which accounted for 35% of all index options yesterday, and 54% of the put volume. That SPX put/call ratio was sky-high with a reading of 5.94, which is the highest reading since at least 1997. With nearly six times as many puts being traded as calls, obviously this should be a notable development. But my issue with SPX options has always been that they are a favorite of institutions looking to sell options to open in order to hedge their portfolios and collect premium at the same time. Because of this, high call volume could be just as bearish as bullish. Our SPX put/call bid/ask ratio can give us a hint on this, and yesterday it showed an extremely low reading of 0.36, meaning that there was a strong bias towards buying puts and/or selling calls. Looking at the back-month options (i.e. those other than the January expiration), 11% of call volume went off at or below bid, while only 2% went off at or above ask. That 2% figure is one of the lowest I’ve seen over the past year, and suggests that SPX traders certainly weren’t scrambling for call exposure.
Looking at the SPX put/call ratio back to 1997, extreme SPX put/call ratios tended to coincide with market turning points, but they were bottoms just as often as tops. I looked at how the S&P 500 performed after extreme SPX put/call ratios (with “extreme” being defined as a reading more than 2 standard deviations away from the mean), and the results showed that extraordinarily high put/call ratios lead to a very minor negative performance in the S&P around 5 days later, particularly when compared to very low put/call readings, but the differences were so very slight that in my opinion they are meaningless. Looking at recent occurrences of high SPX put/call ratios, the conclusion is the same – I can find no consistent edge.
We have some battling forces at work here, to an extent greater than usual. On the one hand we have a positive historical bias over the next couple of days (with the market being up greater than 60% of the time over a decent sample size) coupled with a market in which many issues and broader market indexes are hitting new yearly highs. On the other hand, we have indications that short-term speculation is heating up and is close to the boiling point, to go along with many longer-term measures showing a near-historic level of bullish opinion. While this seems too “scripted” to me, the most likely course of action would be choppy to higher action over the next couple of days followed by enough of a decline next week to wring out some of the excessive speculation we’re seeing. If the inevitable decline is pushed back until after the beginning of the year, I believe it will be much sharper than if it happens sooner. The way things are looking right now from a sentiment standpoint, and with all due respect for seasonality and the good technical condition many stocks are in, I don’t see a whole lot more upside potential, but the risks are greater than they’ve been in weeks that we’ll see a decline of at least a couple percent.
- Jason Goepfert
Disclosure: long QQQ puts
This disclosure is not intended as trading advice in any form. It is meant as a note to subscribers that the author may have a position directly affected by the market outlook reflected in the commentary. Although the author takes great pains to remain objective in any commentaries, it is only fair that readers should know that the author may have taken positions in accordance with his market outlook. Positions can and do change at any time, without notice to the reader.
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