bernie shaeffer's contrarian views:
summary:
- anecdotal sentiment is "over-the-top bullish"
- high put activity might be selling of puts: '(as reported in the 5/24/04 issue of Barron's) "more strategists and brokers have begun reminding investors to consider selling options."'
- in February 2004 the CBOE volatility indices (VIX and VXO) reached their most oversold extremes for the past 20 years - more oversold than the period ahead of the 1987 crash and more oversold than the period ahead of the bubble peak in 2000.
June Option Advisor Commentary: It's All Good?
Bernie Schaeffer
6/3/2004 7:30 AM ET
The following is a reprint of Bernie Schaeffer's market commentary from the June edition of the Option Advisor, published on May 27. Prices and the chart are as of the close on May 27. For more information or to subscribe to the Option Advisor, click here.
"After 23 years of falling interest rates, the U.S. is at a turning point. When it comes to easy money, the party's over. But we should be fine." Fortune, May 17, 2004
"This time, Fed tightening shouldn't make you tense." Business Week, May 24, 2004
"Yes, prices are rising, but not to worry." Business Week, May 31, 2004
"Why a dose of inflation is good for you." Time, May 24, 2004
"I don't see a problem with mortgage rates unless they go above 8% and I don't know anyone who has a forecast that outrageous." Jim Smith, chief economist of Industrial & Office Realtors, as quoted in BusinessWeek Online, May 20, 2004
"The optimist proclaims that we live in the best of all possible worlds; and the pessimist fears this is true." James Branch Cabell (1879-1958), The Silver Stallion, 1926
At Schaeffer's Investment Research, we refer to the "feeling tone" regarding the market and the economy as expressed in the financial media as "anecdotal sentiment." And as I write this commentary, anecdotal sentiment (a sampling of which is listed above) can only be described as "over-the-top bullish." So extreme is this optimism that it eagerly incorporates such legitimate concerns as rising interest rates and accelerating inflation and slowing economic growth and $40 oil into a mosaic whose theme is "It's all good!" If you understand that over-the-top bullishness on the part of Wall Street opinion leaders as expressed in the mass media has very worrisome implications for the stock market, then you have my permission to be very worried.
But "anecdotal sentiment" can encompass more than the mood reflected in media headlines. For example, it has been reported over the past several months that two of the most successful electronic exchanges are moving toward going public. The last instance of buzz about stock exchanges planning IPOs was in the months ahead of the peak of the 1990s bubble.
And if you recall the period ahead of the 1987 market crash, you are familiar with the near-mania for selling puts on the stock indices that, needless to say, ended in disaster. So it is less than reassuring these days when (as reported in the 5/24/04 issue of Barron's) "more strategists and brokers have begun reminding investors to consider selling options."
Moving from the anecdotal world to the quantified world of volatility indices offers little solace. I prefer to use overbought/ oversold indicators when gauging long-term extremes in the volatility indices. Such an approach avoids the issue of differing "normal" levels of volatility at various points in time and instead focuses on extreme movements in volatility regardless of level.
When the volatility indices are oversold, it means they have been aggressively declining for an extended time period. By implication this means that investors have become very comfortable with selling option premium, in large part because they see little probability of a major market decline. Unfortunately, it is during such periods that the market becomes most vulnerable to downside shocks. So it was not at all comforting when I recently determined that in February 2004 the CBOE volatility indices (VIX and VXO) reached their most oversold extremes for the past 20 years - more oversold than the period ahead of the 1987 crash and more oversold than the period ahead of the bubble peak in 2000.
A market that is highly vulnerable to a major decline is by no means a market that must crash tomorrow. In fact, such a market is likely to have built up a good deal of upside momentum in an environment where the news backdrop is good (or is interpreted as good). As such, new money continues to flow into the market and even investors with concerns and misgivings are reluctant to leave the party too soon. As Yogi Berra was purported to have said: "It ain't over till it's over." Until it's over, I will continue to look for pockets of opportunity on the long side while playing the big blue chips on the short side. But when it's over, it is likely to be so ugly that it will be a long, long time before investors dare to fall in love with stocks again.
