Monday, November 26, 2012

Irrational Exuberance

Apple: Market Leader.  Five Down, Three Up.  Trend is down.

Yesterday, Zerohedge showed bullish speculative positioning at multi-year record long going into year end. Today they kindly reminded us that the market has fully decoupled from economic reality. Bear in mind that the ECRI leading index includes the stock market as a leading indicator, meaning if the market was not going up, the ECRI would already be going down. As you see from that ZH chart, the market has a habit of converging to the downside with economic reality - as it did in 2008 and 2011.  Like I said before, the party is already over, so all we are doing now is waiting for Wall Street to come down off of Dr. Bernankenstein's latest dopium fix...

Today, the index option put/call ratio was the lowest level in six years of recorded data, at .47.  This ratio measures the amount of market put protection being bought relative to upside call options.  Low values indicate extreme bullishness.  Looking at the six years of data (1527 days), the highest value in six years of data is 3.5, to give you an idea of the range (.47 - 3.5).  On 85% of days, the ratio was greater than 1, because index puts are usually used to hedge portfolios.  You can see in the partial dataset below, I sorted by the P/C ratio lowest to highest and copy/pasted the lowest P/C values.  Out of the 12 days with the lowest P/C ratios in six years, four occur in just the past six weeks.  I'm no statistics expert, but I calculate the odds of that happening randomly, given this size data set, at the limit approaching zero:

BTFD - So Says Don Hays
Remember back in September, Don Hays one of the most followed market timers on Wall Street told everyone to BTFD on the next pullback.  Right after that is when these put/call ratios above started hitting new lows.  It turns out Wall Street took his advice and went All In and are therefore now expecting a 30% run into year end according to Hays.  The other bullish advent I keep hearing about is the "Zweig Breadth Thrust".  Apparently we are just a few ticks away from tripping this ultra-bullish signal.  The ZBT is a very rare technical indicator that signals a new bull market.  Bulls are excited, because the last major signal was in March 2009 kicking off this four year rally.  Wouldn't you think people would differentiate between a signal given back then after a 60% decline in the midst of overwhelming bearishness v.s. one given after a four year rally with the market 6% from a multi-year high in the face of a deteriorating economy?  And the fact that it's rare (15 instances since 1945), just means that it's statistically unproven, or to paraphrase Nassim Taleb, randomly lucky speculators will keep doing the same thing over and over again until it blows up in their faces.  Like the ECRI, the ZBT has a circular reference with the market i.e. the overzealous actions of speculators feeds back into this indicator, potentially setting themselves up for their own self-generated false positive.

Lastly, how do you like my Elliot Wave analysis of Apple above - Not too bad?  Bear in mind, there is no way to know for sure if the a-b-c retracement is "over" until price folds back under "b".  Speaking of Elliot Wave, the EWI types are leaning bullish short-term, assuming the market retracement is not yet complete.  To have the world's most bearish (paid) newsletter leaning bullish, is a necessary but not sufficient condition for a crash i.e. everyone needs to be on the same side of the boat.  You can generally assume that if they are bullish, everyone else is too (save for wingnut bloggers).  Granted, if EWI get this one wrong (again), I am cancelling my subscription - because as you can see from my Apple chart above, I have the financial astrology down pat.