The Pullback in Stocks May Not Last Much Longer

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The benchmark S&P 500 Index sank to a fresh four-month low last week…

Concerns about the rapid rise in interest rates weighed on the index. It’s now down about 4% from its July high.

The weakness has been tough on nearly every sector in the market. And now, broad investor fear is spiking as a result.

But believe it or not, this is actually a bullish sign for stocks in the long term…

You see, as I’ll explain today, activity in the options market indicates the market pullback may not last for long.

Traders and investors alike have been loading up on put options…

That makes sense. Put options are a leveraged way to bet on falling stock prices. And falling prices are exactly what most investors expect today.

When you compare the volume of put options traded with the volume of call options (which are a leveraged way to bet on higher stock prices) on any given day, you get a good gauge of overall investor sentiment…

Big spikes in this ratio – called the put-to-call ratio – can show us when folks are too pessimistic about the market.

As you can see below, the put-to-call ratio jumped to more than 1.5 last Wednesday. That was its highest level since December 2022. And it was a clear sign that market fear had taken hold…

Now, you might think that traders buying more puts than calls is a warning sign. But it’s the exact opposite

The last extreme in the put-to-call ratio was on December 21, 2022 – when it jumped above 1.5 for the first time in more than a year. That happened near the lows of a market pullback that had started earlier that month… And roughly seven months later, the S&P 500 was up 20%.

According to Ryan Detrick – the chief market strategist at the Carson Group – this is a common pattern. Since 2010, stocks were up three months after similar spikes in the put-to-call ratio… not just generally, but 100% of the time (with eight total occurrences). Their average gain was 8.7%.

Six and 12 months later, stocks were up an average of 13.8% and 20.6%, respectively.

You can see these prior put-to-call ratio signals plotted on a chart of the S&P 500 below. Notice how extremes tend to occur near market bottoms…

Clearly, folks are worried about the market right now. But historical trends indicate that now is not the time to panic. If the trend holds, we could be in for a sharp snapback rally in the near term.

Last Friday’s strong non-farm payrolls data was a step in the right direction. Approximately 336,000 jobs were added in September – more than double the expectation of 171,000. That ignited a sharp reversal in stocks, with the S&P 500 closing the day more than 1% higher.

Of course, it’s too soon to officially call the bottom. But the big spike in fear should give you confidence in stocks today.

Here’s to the future,

Matt McCall


This article was originally published on this site