One of the conditions for a retest to happen, or even for the market to go down, has been sentiment. I often say everyone needs to be back in the pool before we can go down again.
In late December the pool was empty. We know this because not only did the put/call ratio reach its highest level ever at 182% on December 20 but the first week of January the Investors Intelligence bulls came down to 29%, having been twice that in early October.
For two weeks now I have expected the Investors Intelligence bulls to turn more bullish yet this week's reading was still only 45%. Perhaps after the big cap tech earnings and the Fed this week we'll see these folks back in the pool. The one thing we know is options buyers are shifting.
Nearly two weeks ago the put/call ratio for the VIX was 20%. Let me stop here and note that low put/call ratios tend to be bearish for stocks because it means too many calls bought relative to puts. However when it comes to the VIX it implies a large bet on VIX calls relative to puts which is a bet on a higher VIX and therefore a lower stock market, thus put/call ratios under 20% tend to be market bullish.
Wednesday's put/call ratio for the VIX is a total about face with a reading of 113%. That is a bet on a lower VIX (and therefore a higher stock market). It doesn't get into the triple digits often. In fact it only did so three times in the last year. We saw this twice in June (arrow on the chart) and then in early November.
In June it took a few days but the market did roll over into a correction. In November, the reading was the on Election Day and we rallied hard the day after the election but that was that, down we went. I would grant you both were different market climates but I am trying to show you the shift in sentiment that is taking place. Folks have now placed more than a toe in the water, perhaps an entire leg or two are in.
The 10 day moving average of the equity put/call ratio sits at 62%. Readings under 60% have typically meant everyone is back in the pool.
Another ingredient has to be weak breadth and we don't have that by any stretch of the imagination. What we do have is small caps underperforming which is often a precursor to poor breadth. In fact the small cap ETF IWM relative to the large cap SPY has been sideways for weeks now.
To follow up on yesterday's discussion with regard to the small caps relative to Apple (AAPL) you can see the drop-off was strong. This doesn't mean the Russell 2000 is in bad shape, just that it has begun to yield to larger cap stocks.
The market is not yet overbought on an intermediate-term basis (I have that pegged for late next week) and breadth is still good. In addition, sentiment is not yet giddy. But we'll keep an eye on the potential for breadth and sentiment shifting.