One market indicator I frequently look at on Real Money is the equity put/call ratio. Wednesday's equity put/call ratio sunk to 40%, its lowest level in six years.
What should we make of this?
I looked back and found six times when readings for this indicator were lower than 40%. Let's take a look at these instances because they are quite interesting.
First, with no chart because I am certain we all know how this story ended, there was the reading at options expiration in December 2007. I remember it well because I rationalized it as being a year-end expiration reading. We know how that turned out since the S&P 500 made its high two months prior and did not see that high again until after the bear market.
Lesson: Never rationalize an indicator.
The next instance we saw the equity put/call ratio lower than 40% was a few months after the March 2009 low, in late August. All we got then was a quick 5% correction.
There were two such readings in 2010.
The first was early April. You can see in the chart, below, we rallied, or at least didn't go down much for a month. Then we got the Flash Crash.
The other reading arrived in late August after the market was already down quite a bit. The market plunged 3-4% and made a low. Folks might remember this coincided with Fed Chair Ben Bernanke's Jackson Hole QE2 speech.
The years 2011 and 2014 have much in common in what transpired after their low readings.
In 2011, the low reading arrived in January and led to a mere 2% correction and a 5% rally thereafter. But step back and note something else: not only did the 6% rally lead to a 7% decline rather quickly but it was the beginning of a giant sideways period that led to a top and massive drop that summer as the U.S. debt was downgraded.
In 2014, we got a few days of pullback but mostly we were in a chopfest for the next six weeks. The market dropped, rallied and then plunged into what folks might remember as the Ebola Scare in October that year.
If you are looking for something that provides instant gratification you may or may not be thrilled with these statistics, depending on your time frame.
In the big picture, out of these six readings, four of them were part of a topping process. One gave you an immediate plunge and nice rebound (2010) and one gave you a mild correction that then went on to rally for months (2009). It's a matter of whether you think now is like August 2009, August 2010 or some other time.