|
|
|||
|
|||
|
|
Wilkinson's Edge: A Clue from the Futures Market MoneyNews
Dear MoneyNews Reader, A Clue from the Futures Market Last weekend, as I do every Saturday, I sent my usual eLetter to members of NewsMax's SectorTrade service. My role is to recommend investments in those sectors that I believe will eclipse the others, come bull or bear market. As always, I noted key market-moving observations and illustrated how they would impact the sectors in which we are currently invested. Story Continues Below
One of my findings at the time was pivotal in my decision to make a fresh sector recommendation to members that week. If you recall, stocks had been in freefall as investors haphazardly threw the baby out with the bathwater. But by offering a little insight into the world of options trading, I hope I was able to confirm that a good buying opportunity was fast approaching. Keeping well away from the selling frenzy, I employed a little-used indicator of investor sentiment to pinpoint a potential climax in selling pressure. And I thought I should share my observations in today's column to illustrate why I feel like we may see a strong finish for the remainder of 2005. I'm talking about the "Put/Call Ratio." Equity options are traded at the Chicago Board of Exchange (CBOE). For those of you new to options, these instruments allow buyers and sellers to bet on the rise or fall of a stock - by locking into prices today. One of the CBOE's roles is to facilitate the open outcry market in options and to track the total volume of each series of puts and calls of all American equity options. The CBOE publishes a daily index of the put/call ratio. An option buyer uses call options to get bullish about stocks, while put buyers are bears. The chart below compares the S&P 500 index to the put/call ratio.
For example, if one put were traded for every two calls, the daily value would be 0.5. Since call volume is generally greater than put volume (because investors tend to be optimists), the value of the index tends to be less than one. Note the scale on the right side of the chart, which indicates the ratio value. The blue line illustrates the S&P 500 index using the left-hand scale. The green line depicts the sentiment of options speculators as measured by the amount of bullish and bearish plays they are putting on. I have highlighted two important areas on the chart. The first is the low at the time of writing (Oct. 13), and the second is from around April 20 in the equity market. Here's how this analysis works. First of all, as I said, most investors are optimists. They are more prepared to buy calls in the hope that the market will rise than they are to buy puts in fear that the market will take a nosedive. So when the put/call ratio is calculated, we expect a value of less than one. Second, when times are good, an increasing number of investors joins in on the euphoria and buys more calls in expectation of easy profits. That forces the put/call ratio value down. At the opposite extreme, when pessimism abounds in the market, we see a variety of put buyers spring into action. That group includes investors who are currently bearish and willing to sell the market short. But it is also comprised of buy-and-hold investors who are watching their daily profit/loss slip down the drain, forcing them to sell equities. The more shares fall in value, the more investors absolutely have to take action. That forces them to take cover by aggressively buying put options. The net effect is that we see a surge in the put/call ratio as near-term sentiment sees investors scrambling to protect their portfolios - whether they like it or not. See what happened earlier this year, when the equity market fell toward its lowest point for 2005? Take a look at the interesting spike in the put/call ratio, which was recorded at 1.03 on April 15. For every put purchase, there was a call buy. Just five days later, the equity market hit its low point before rallying to a new high for the year. Just as investors rushed in to protect themselves during the April plummet, the other week we registered a put/call ratio of 0.93. At that time, I advised SectorTrade members to use the opportunity to buy into what might be a bottom formation in progress. Since then, the put/call ratio has edged back to a more normal value. On Wednesday, equity markets exploded to the upside, with the S&P 500 putting in its best daily performance in six months and the Dow rising 128 points in that day's session. The rally seemingly came from nowhere. But then again, you have to know where to look. Bonds and Inflation Stocks spent a second week battling the stiff headwinds of inflationary pressures. Raw material prices rose at their strongest pace since 1990, just before the economy slipped into a three-year recession. Still, the bond market acted in a more even-tempered manner in light of the latest batch of data, as yields failed to rise beyond last week's 4.53%. Why might that be? The answer lies in the difference between the nature of the raw data and the core data. In the 25-year chart below, you can see the latest data have taken the overall Producer Price Index back above 5%, where it has been contained for the last three years.
But before we jump off the springboard and scream about rampant inflation, we need to consider two points: First, the primary source of this inflation stems from the rise in demand for energy products. Further supply bottlenecks seem to be aggravating the problem. Not to gloss over the soaring global demand for oil, but the more recent source of the energy crunch dates back to Hurricane Katrina. Since August 31, when the hurricane hit, oil prices have fallen back, oil prices have fallen back, although refined products (gas and heating oil) are anticipated to shoot higher. Looking ahead, we will not be facing similarly huge oil price hikes, given the abundant supply. Second, while there is clear evidence that supply constraints and material prices are being passed on from one manufacturer to another, it's far from clear that inflation is becoming rampant. That could be why bonds failed to sell off on the news. Slowly but surely, bond prices are manifesting and exhibiting the effects of more and more Fed tightening. Every speech, every data release, every rally in oil has seen bonds slump into a dizzying tailspin over the last three months. Up until that point, bond investors seemed sure that the Fed was almost done with tightening monetary policy. But then the dam burst, sending scared investors running for the hills. Just this week, Fed member Ferguson commented that the current policy of raising rates at a "measured" pace was still the correct one. Meanwhile, non-voting member Janet Yellen said that the "neutral" rate may be as high as 5.5%. The current 3.75% Fed Funds rate has a way to go, and I must point out that currently the market is not braced for that outcome. If bond traders price in this eventuality, it could make for a continued sour tone. However, neither commentary managed to budge treasury notes and bonds lower this week, and there even seemed to be a little bounce for the week. For now, at least, inflation from the energy complex is serving as a drag on growth. And as such, it's weighing heavily on global stock markets, which even enhances the appeal of fixed income - regardless of promises of higher short-term rates. Commodities Corner Since I'm closing up shop early to finish the weekend (courtesy of Hurricane Wilma) I thought I'd take the time to review a couple of recently analyzed commodities trades that are directly related to the hurricane season. If you care to review the original recommendations that I made on both orange juice and coffee, simply use the links below: http://www.newsmax.com/archives/articles/2005/8/12/194011.shtml http://www.newsmax.com/archives/articles/2005/9/23/232714.shtml But the bottom line with each trade is that the picture in the charts says it all. In mid-August I asserted that the trend in orange juice futures just wasn't playing fair, with the likelihood that hurricane season was going to arrive in no uncertain terms.
I also made the point (behind a strong fundamental argument about how underpriced coffee futures were) that the additional strain from potentially flooded coffee warehouses could send the price of coffee beans up from 86 cents per pound into the $1.05-$1.10-per-pound range. Once again, the chart paints the picture.
Of course, we have discussed oil recently. Regular readers of NewsMax's MoneyNews and Financial Intelligence Report know that we have been oil bears over the last month or so. Look at the following crude oil chart. The apparent supply glut following the refinery stoppages in the Gulf of Mexico says it all.
Let's end on some even better news. I'll let you in on a little secret. I am just putting the finishing touches on my brand new Options service that will soon be offered to a select, limited number of members of the MoneyNews.com family. I can't say too much about it right now, but I can tell you that I am super excited about this-and I'm sure you will be too. The results have been eye popping. So keep an eye out for a special invitation in upcoming issues of MoneyNews and Wilkinson's Edge. Better yet, if you want to be sure and get a special invitation please send me an e-mail at andreww@newsmax.com. I'll put you in my special VIP list to assure you get one of the first invitations. Have a great week! Andrew Wilkinson
|
|
||||||||||||||||||||||||||||||
Wilkinson's Edge
Print Page 
Forward Page 
|
| All Rights Reserved © 2012 NewsMax.Com |