Stay on Your Toes

 | Jan 17, 2012 | 6:27 AM EST
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I liked the way the market pulled back on Friday. Clearly so did everyone else. From the way the index put/call ratio sunk like a stone on Friday, I can see the action got quite a few all bulled up.

But someone, or perhaps several, made a rather large bet on a higher VIX as the put/call ratio for the VIX sunk as well to a very low reading or under 15%. So, we have too many calls being bought on the indices and too many calls being bought on the VIX. One of those says folks are all bulled up and the other says folks are all beared up. And it's not as if one is a mild reading. They are both quite extreme.

I did not expect to find any other readings so conflicted, but I managed to find three other times in the last three years where we had a low index put/call ratio and a low VIX put/call ratio. It turned out both sides were correct.

If we go back in time, the last such instance was just over a month ago, on Dec. 6. I have circled it on the chart.

Prior to that we have to go all the way back to Feb. 1, 2011. You can see the big pop up the very next day, more than 1%, followed two days later by a fast 5% decline. So, the bulls got their rally and the VIX bulls (bears on the stock market) got their decline.

Then we have to go all the way back to May 5, 2009. Here we see the bulls got their rally the very next day, then the bears got their decline, then the bulls got their rally and then down we came. That time was definitely volatile.

Considering the indicators I follow continue to say pullbacks should lead to re-rallying, I actually think these sentiment indicators above make quite a bit of sense. It is an options expiration week and the European news should keep market players on their toes, not to mention earnings. It says to me both bulls and bears should avoid complacency in the next week or so.

I realize Nasdaq has not acted nearly as well as the S&P in this rally, as many of the big names in four-letter land have lagged. So, it came as a surprise to me when I saw that the Hi-Lo Indicator for the Nasdaq actually made a higher high for the first time in more than a year.

The red line on the chart is now higher than it was in late October/early November, yet Nasdaq has not yet surpassed that high. Now look at the chart and notice that the indicator has not made a higher high since the latter part of 2010. Every single rally in this indicator has been a lower high, even when Nasdaq was making higher highs through the spring of 2011. We can put this indicator on the intermediate-term bullish side of the ledger.

In the shorter term, those conflicting sentiment indicators say neither bulls nor bear should be complacent this week.

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