Equity Put/Call Ratio Approaching 1.0

In the third week of August last year we noted the equity put/call ratio had climbed above 1.0 as noted in the post, Equity Put/Call Above 1.0 Again. As we wrote in that post,

"The equity P/C ratio tends to measure the sentiment of the individual investor by dividing put volume by call volume. At the extremes, this particular measure is a contrarian one; hence, P/C ratios above 1.0 signal overly bearish sentiment from the individual investor. This indicator's average over the last 5-years is approximately .7, indicating the individual investor has been generally mostly bullish and more active on the call volume side"

The S&P 500 Index closed at 1,123 on 8/19/2011 and traded sideways to down before reaching a low of 1,099 on 10/3. So from August 19 to October 3 of last year, the S&P fell an additional 2.1% after the equity put/call ratio rose above 1.0.

Well, here we are today with the P/C ratio approaching 1.0 again and bearish sentiment at elevated levels.

From The Blog of HORAN Capital Advisors

The news that triggered the decline last year is not too different from the news impacting the market currently. Following is what we wrote in August last year.

"At HORAN, we believe business fundamentals are contrasting with equity market actions. This divergence is being driven in large part by the lack of confidence in Europe in dealing with its sovereign debt issues and in Washington's inability to deal with its budget deficit. Additionally, the amount of regulatory uncertainty that includes health care reform and potential income tax reform is a factor in business' ability to commit to longer term expansion plans."

Liz Ann Sonders, Chief Investment Strategist at Charles Schwab, notes,

But there is a long list of positive offsets this year relative to the past two years:

• Inflation is coming down, especially among commodity prices.
• Credit growth is quite strong, especially for consumers.
• Housing has improved markedly.
• The US manufacturing sector is humming.
• NFIB's small business survey made recent upside breakout.
• Job growth is much better.
• Consumer confidence is improving.
• Private-sector leverage ratios are much improved (debt servicing costs are extremely low).
• Recovery in state/local government spending.
• The US economy somewhat decoupling from rest of world; at least Europe.
• US bank capital/health is much better than Europe's.
• The European Central Bank's Long-Term Refinancing Operations have reduced likelihood of global financial contagion.
• Germany appears more willing to accept higher inflation, opening the door to easier monetary policy for the eurozone.
• Valuations are quite cheap, especially on forward earnings.
• Investor sentiment has improved sharply with the correction to-date (meaning pessimism has kicked back in).

It is difficult to predict a market bottom and certainly the S&P 500 index could trade lower in the very near term; however, business fundamentals look positive and sentiment is approaching levels indicating pessimism may be overdone.