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A Contrary Review


Looks pretty muddled to me!


Every few months, I like to update a series of guides that I find to be effective measures of wrong-way investor behavior.

The last update was back in April, at which time they didn't show much of an edge in the short-term, but the increasing evidence of risk-aversion in spite of rising market prices was something I considered to be a long-term negative.

If traders were beginning to eschew risk when prices were hitting new highs, then it makes sense to think that they would really be doing so after the decline we've seen over the past couple of months.

Let's take a look.

The equity-only put/call ratio did get to something of an extreme in mid-June, approaching a level previously seen at lows over the past couple of years. Other ratios, which take into account index options as well, spiked to historic extremes, so one could have certainly made the argument that pessimism was excessive. Over the past two days (according to the ISE), traders bought to open more puts than calls - that's a good sign, but we need to see more of it.

The SPY Liquidity Premium, which measures the demand for liquidity by comparing volume in the S&P 500 exchange-traded fund to the volume in the underlying components, also spiked to an historic level in mid-June. That type of persistent demand for liquid instruments had been matched only by major market lows in 2001 and 2002, so that was a strong signal that we had reached a potential inflection point. Over the past couple of weeks, however, we have not seen a similar flight – traders have been just as content to trade individual equities. That's generally not a positive sign during a declining market.

Total assets in the Rydex leveraged bear funds have not moved much over the past few months. I have my misgivings about some of this Rydex data, mostly due to the fact that they have become much less trend-following in nature, and also due to the increasing number of fund alternatives, like the new Profunds leveraged and inverse ETFs. It's quite possible that watching these leveraged fund flows at Rydex will become less useful (or even totally useless) going forward, so I'm not sure how much confidence we can have in these readings.

Odd lot short sales spiked to new record highs in mid-June, in keeping with the theme that we saw a huge amount of skittishness across the board last month. Once again, however, over the past few weeks they stopped pressing their bets against the market. In fact, a few days ago this indicator touched the "complacent" trading band I use for it, so obviously we're a ways away from saying that these guys are currently too pessimistic.

Overall, what we've seen over the past few weeks isn't terribly unusual given the historic extremes a few of these indicators reached – as markets rebound from an emotional low, we have to expect traders to relax their tensions a bit. But we haven't seen a resumption of the high fear levels lately, in spite of indexes like the Nasdaq 100 making new lows for this move. That's troubling, and something that needs to be watched closely.

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