May 12th, 2022

Is This Indicator Signaling A Bottom?

The Consumer Price Index showed an uptick in prices as inflation for the month is showing a slight deceleration.  The key to remember is that we’re now comparing inflation numbers to a year ago as it started to spike last April, so the good news, in this case, isn’t quite what it seems.  We’re comparing a high number in April against an even higher baseline from a year ago.  That doesn’t signal that we’re out of the woods.  

 

The pressure on the market is coming from several factors (in no particular order):

 

  1. War in Ukraine

  2. Inflation

  3. Rising interest rates

  4. China lockdown from new COVID outbreaks

  5. Supply chain Issues

 

One or two of those things are difficult enough to digest, but altogether they are dragging the market down.  Even bank stocks that do well in periods of rising interest rates are struggling to hold ground.  It just shows how difficult it can be to cherry-pick stocks in this market. 

 

But is this one indicator showing us that there is some relief in sight?

 

Below is the one indicator that may predict a market turnaround.

 

The CBOE Equity Put/Call Ratio takes the number of put options traded divided by the number of call options traded.  Since more investors trade calls, the typical baseline for the ratio is 0.7.  If the put-call ratio is increasing, equity traders are buying more puts than calls which suggests a bearish sentiment in the market.  Likewise, a put-call ratio that is falling and lower than 0.5 indicates a bullish sentiment in the market.  

CBOE Equity Put/Call Ratio

Over the last six months, we’ve seen extended periods of an increased put-call ratio with few dips below 0.5.  With the recent spike up to 0.78, a retracement here seems probable, which means we could see some short-term relief in selling but, that does not mean we’ve seen a bottom.

 

Looking back at a five-year chart we see the 2018 selling turned around when the put-call ratio spiked at a reading of 1.13 and in 2020 during the covid collapse, the put-call ratio spiked to a value of 1.28.

CBOE Equity Put/Call Ratio

 

I believe there will be a shakeout day where the market drops anywhere from 3-5% in a day and we’ll see a spike in the put-call ratio and that will indicate a market bottom, just as full panic takes place.  I don’t believe we’re there yet.

 

A key emotional level for the SP500 (SPY) is $400.  Traders like the main numbers that end in 0’s and 5’s.  A break below that level and there’s a weak level of support around $370 and not again until $340.  If we can’t hold $400, I think there’s a strong possibility of another 7% drop and I don’t see enough of the five problem areas clearing up soon enough to help hold the $400 level.

 

If you have any questions, comments, or anything we can help with, reach us at any time.

 

 

 

Jeff
Guest Writer, Filthy Rich, Dirt Poor
Editor, Wealthy Investor Society

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