Extreme Readings from the Equity Put/Call Ratio as the NYSE McClellan Hits Oversold Territory

Stock indexes settled lower Friday in choppy trading. Breadth closed near 2:1
negative territory, sending the cumulative breadth line below its January low
and confirming the recent breakdown by the S&P. Keep in mind, however, that a
new 52-week low for the S&P is often followed by a rally over the next couple
of weeks, particularly when the breakdown occurs on decreasing volume (see my
March 6th column).

It's interesting to note that the CBOE equity put/call ratio closed over .90
for the second day in a row Friday, meaning over nine puts traded for every
ten calls in recent sessions. That's the kind of fearful action typically seen
near intermediate-term bottoming periods. In the last decade, there have only
been eleven separate instances in which the equity put/call ratio closed over
.90 two consecutive days. In most cases, the extreme level of put activity
ended up leading to higher prices ten trading days later...

CBOE Equity Put/Call Ratio Over .90 Two Days
03/07/08... S&P500 ??? two weeks later
01/18/08... S&P500 +4.2% two weeks later
08/15/07... S&P500 +4.1% two weeks later
07/07/04... S&P500 -2.2% two weeks later
06/14/04... S&P500 +0.7% two weeks later
05/12/04... S&P500 +1.6% two weeks later
08/28/03... S&P500 +1.6% two weeks later
02/06/03... S&P500 +1.2% two weeks later
09/17/02... S&P500 -2.9% two weeks later
02/05/02... S&P500 +0.7% two weeks later
09/21/01... S&P500 +10.9% two weeks later
09/18/01... S&P500 +1.8% two weeks later

This doesn't rule out the potential for further weakness near-term, especially
considering the market's failure to rally following Thursday's 90% down volume
session. This kind of action can often lead to another 1%+ on the downside
(intraday).

One early clue regarding the market's general health will come by mid-week.
The reasoning is that Friday's negative breadth stats sent the NYSE McClellan
Oscillator below -200, typically a sign that selling pressure is at or very
near a short-term exhaustion point. The last thirty instances in which the
McClellan initially closed below -200 are listed in the table below. Note that
in the majority of cases, the S&P was trading at a similar level or higher
three sessions later. In only three cases was the S&P down more than 1%, while
it gained 1% or more thirteen times, suggesting further short-term weakness
could prove to be a buying opportunity.

NYSE McClellan Oscillator closes below -200
03/07/08 -208... S&P ???
11/19/07 -254... S&P +0.5% three days later
11/09/07 -234... S&P +1.2% three days later
11/07/07 -213... S&P -2.5% three days later (*)
08/15/07 -257... S&P +2.8% three days later
08/03/07 -213... S&P +4.5% three days later
07/24/07 -228... S&P -3.4% three days later (*)
06/12/07 -253... S&P +2.7% three days later
06/07/07 -258... S&P +0.2% three days later
03/02/07 -228... S&P +0.3% three days later
05/17/06 -223... S&P -0.6% three days later
04/11/06 -200... S&P -0.1% three days later
10/12/05 -239... S&P +1.1% three days later
03/16/05 -229... S&P -0.4% three days later
01/05/05 -212... S&P +0.5% three days later
05/07/04 -275... S&P -0.1% three days later
04/29/04 -216... S&P +0.5% three days later
04/14/04 -249... S&P +0.7% three days later
02/04/04 -206... S&P +1.2% three days later
07/17/03 -239... S&P +0.6% three days later
06/23/03 -227... S&P +0.4% three days later
01/27/03 -237... S&P -0.3% three days later
10/09/02 -248... S&P +8.3% three days later
09/24/02 -212... S&P +1.0% three days later
07/22/02 -258... S&P +2.3% three days later
03/22/01 -230... S&P +5.8% three days later
08/10/99 -228... S&P +3.6% three days later
08/28/98 -216... S&P -3.6% three days later (*)
08/04/98 -262... S&P +1.6% three days later
07/28/98 -220... S&P -0.8% three days later
04/27/98 -271... S&P +2.3% three days later

Given the oversold conditions, it wouldn't be a good sign if the S&P is
trading below 1286.90 at Wednesday's close, as this represents more than a
0.5% drop from Friday's settlement. As I discussed at the end of my November
12th column, when the market fails to rally or at least hold steady in the
three days following such an oversold McClellan reading, it usually means
further downside is in store.

Categories : Archived EOD Commentary, End-of-Day Commentary

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