One would think Thursday's pullback, which quickly squashed Wednesday's recovery hopes and rekindled Tuesday's pullback fears, would have been accompanies by surging investor fear.
One would be wrong in thinking that though... and it could be a problem for the broad market.
The premise of contrarianism isn't a new one, though it IS an underutilized one. Investors either don't understand it, don't believe it, or both. Ergo, they don't employ it. Big mistake. The (sad) fact of the matter is, most traders are most wrong about the market when they're most sure they can't be right. If you can spot the extremes in sentiment, you've usually spotted major turning points that end up surprising - and hurting - traders. Market bottoms are usually made when fear is rampant, and tops take shape when confidence is sky-high.
The opposite approach also works. That is to say, when traders aren't terrified or elated when they should be one or the other, it may be a clue that a pivotal point has yet to be met.
That's what happened on Thursday. Despite a decent-sized 0.7% setback that quelled Wednesday's budding hope and put the market's strength back into question by virtue of a move back below a couple key moving average lines, investors didn't even flinch. It's unlikely the market will hit a tradeworthy low until those traders are terrified.
There are a couple of tools we can use to gauge investor fear. One of them is referred to, conveniently enough, the 'Fear Gauge.' You may know it better as the VIX. Regardless of what you call it, the ratio of put option prices and call option prices, which will change to reflect the growing demand for defensive puts and a waning demand for bullish calls, was oddly stagnant on Thursday. The daily chart of the S&P 500 and the VIX below tells the tale.
One only has to look back to early February to appreciate that major, or even minor, market bottoms tend not to form until the so-called fear gauge is peaking.
The other tool we can use to measure trader worry is the put/call ratio. Once again using options as our basis, we know demand for puts jumps when trouble appears to be ahead. And, the purchase of calls also deteriorates when it looks like the market is headed lower. Despite Thursday's action that could prove to be a bearish catalyst, interest in buying puts and avoiding call options didn't really budge. And, it's certainly nowhere near where it's been at previous market bottoms.
That's what the image below tells us anyway. Once again the S&P 500 is at the top, and at the bottom - in YELLOW - is the daily put/call ratio (marketwide). At 0.88, traders clearly aren't playing defense even though they, perhaps, should be.
The light blue line is a moving average of the daily put/call ratio, indicating its trend. There's value in that information too. Generally speaking, a rising put/call trend is bearish for the market, while a falling put/call ratio has bearish implications. After a pretty good downtrend that coincided with April's rebound effort, the put/call trend line looks like it's starting to point upward again. (It's just not yet reached an unsustainable peak around the 1.10-1.20 area.).
This message also suggests the market's not yet ready to muster a major rally. Rather, it hints there's more downside to play out.
Like all tools, these aren't infallible. They're just another piece of information to consider, to either confirm or at least question other clues. But, they're right more often than not, if you know how to interpret what these clues are saying, and know how to play it.
Could this go-around be an exception to the norm, with the market rallying out of trouble without pulling back to a major low first? Sure. Anything's possible. Take a second look at the charts though, and take note of the fact that it doesn't usually happen like that.
If you're going to fight the odds, history and tendencies, you better make sure you have an outstanding reason for doing so. (And, who knows? Maybe a retreat from the trade war rhetoric and the denuclearization of North Korea could do the trick.)