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Did we hit rock bottom?
March 24, 2008
Since the market peaked in October 2007, it has dropped more than 15% and has almost reached its level from two years ago. Despite the fear of recession and the markets current bearish trend, there are few significant indicators that might give us a hint as to where the market is headed.
The first indicator is the content of market timing newsletter editors, quite frequently are wrong in predicting the market’s direction. History clearly demonstrates that when these investors become too bullish, it is generally a bad sign for the
stock market, just as it is a positive sign when they become overly pessimistic about its future. This notion makes these editors an excellent contrarian indicator for the market’s behavior.
At this point, the editors of most market timing newsletters are betting that the market will continue to decline. Moreover, the newspapers headlines are filled with statements regarding the fears of most investors. Therefore, as unusual as it may sound, this could be the first indicator that the market might be nearing its bottom.
On the other hand, the corporate insiders are now behaving more bullishly than in the past. Insiders are the company officers, managers and the largest shareholders of its stock. Being “on the inside” enables them a better insight of their company’s prospects. This is probably the reason why they tend to be more right than wrong in predicting the direction of the market, at least in the section in which their company operates.
Since insiders are required to immediately report all their trades to the U.S. Securities and Exchange Commission (SEC), it is easy to track their recent movements. According to the Argus Research in New York, which is one of the largest services that collects and analyzes these transactions, insiders are now behaving more bullishly than at any time since November 2002, the month after the end of the 2000-2002 (the dot.com) bear market.
Insiders usually sell more stocks than they purchase since as a part of their income they are awarded with stock options that can be converted to the company stocks. Thus, the average insider selling activity is two and a half times more frequent than their buying activity. Surprisingly, during the week of mid January the insiders sell to buy ratio stood at 0.89 to 1, which means that insiders bought more stocks than they sold. However, the week-to-week sell to buy ratio seems to be quite volatile, thus Argus also calculates the eight week moving average ratio, which is more reliable; its most recent value was 1.44 to 1. The last time this ratio was lower was during the eight weeks that ended on mid November 2002, when the ratio stood at 1.33 to 1. Shortly after this date, the market started to soar for five years, but this ended last October (2007).
Of course, it is not guaranteed that the stock market will behave bullishly for the next five years or for any period of time, but there are good chances that the corporate insiders precede the average investor in tracing the future increase of the market.
What do technical indicators tell us?
A number of technical indications for future recovery of the market are also available. For example, let us analyze the put to call option ratio, which is considered to be one of the main indicators for predicting the markets future behavior.
In general, a call option is a contract giving the owner the right, but not the obligation, to buy a specified amount of an underlying security (stock, ETF, etc) at a specified price within a specified time. A call option becomes more valuable as the price of the underlying security appreciates. In other words, the call buyer predicts a bullish behavior of the security, and actually will receive the appreciated stock in the future at the low price it is traded at today.
A put option is just the opposite; it is a contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a set price within a specified time. Therefore, the put option buyer profits when the price of the security goes down. In other words, the buyer of a put option estimates that the price of the underlying security will go down and drop below the exercise price before the expiration date. He therefore sells the stock at today’s prices but will deliver the stock in the future when its price dropped.
Putting the above two points together, the put to call ratio presents the ratio between bearish to bullish investors; as the ratio has higher values, there are more investors predicting the market is going down, where as if the ratio becomes lower, it means that more investors are predicting that the market will go up. Take a look at the chart below, showing the put to call ratio in the last 12 months.
As you can see, the ratio (plotted in the blue line) is quite volatile on a daily basis. However, when averaging it on a more reasonable two week period (shown in the red line), its longer-term trend becomes clearer. Currently, the put to call ratio is close to a point where it has bounced back in the past (the yellow line). In the stock market this line is sometimes called- “support”, meaning the price of a stock does not go lower (unless of course there is a crush of the market or the specific company…).
The question is, will the market bounce back returning to the bullish behavior, or will it continue to decline and deviate from its past performances? Technical indicators, such as the put to call ratio, are used by a large number of investors to determine their investing behavior and assist them to time the market; thus, the odds for a near market bounce might be higher than what is commonly predicted.
Obviously, it is difficult to accurately predict the near future behavior of the market. However, one of the great features of
Yalicoo is that you can test your prediction without risking any of your savings. In addition, you have the opportunity to watch how other
Yalicoo investors interpret the market moves and improve your understanding and behavior even in a volatile market such as the one we are currently experiencing.
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