I'm Doubting a Plunge

 | Jan 04, 2015 | 6:00 PM EST
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When you consider that just a week ago folks were of the mind that the Santa Claus rally would continue right into the New Year and all that seasonality during early January would keep the market moving steadily higher, there was quite a change in sentiment during Friday's trading.

First we had the S&P up nearly 15 points, followed by a plunge where it was down about 12 points. It was that plunge that brought the bears out of the woodwork. How else can we explain the total put/call ratio zooming upward to 122%? You either loads up on puts relative to calls if you are bearish (buying puts to bet on the downside) or dying to hedge your already-very-long portfolio (buying puts to protect or hedge).

My suspicion is the latter rather than the former, just based on the fact that we saw those giant inflows into U.S. equities just before Christmas and the money had likely been put to work (so folks were more interested in hedging). In any event, the 10-day moving average of the put/call ratio did not tick up, but is likely to do so in the coming week.

To offset this rather bullish reading for the put/call ratio we saw the ISE Equity ratio dip under 100%. You might recall that typically a reading under 100% comes in the middle of a correction. For example, the last such sub-100% reading we had was in fact two readings, back to back on Dec. 11 and 12 (arrow on the chart). It took the market three more days to bottom and find an oversold condition.

Quite frankly, I doubt the market can plunge the way it did in mid-December right now for a variety of reasons. The first reason is that it is the first few days of the New Year and money often flows in at this time of the year, supporting the market the way it did on Friday. Secondly, it is that the market has already been down three to four days in a row. But, if it can manage to chop around with a negative bias and then have one sharp down day, that would lead us back to an oversold condition -- and a decent oversold condition at that.

Notice as well the uptrend line I have drawn in on the chart of the S&P above. As you go though many of your stock charts, I would bet you see that similar line in the individual stocks, lines that connect the October low with the December low. Many big-cap stocks have come down to those lines in the last few days.

Wouldn't it be a perfect setup if the S&P came down and broke that line just as we were getting oversold? If Friday's action panicked them enough to load up on puts, can you imagine what a break of that uptrend line would do? And surely the VIX would be jumpy to go along with it. Yet my fear, as usual, is that they will save us before we can get that better setup.

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