Is the Market getting complacent? We look at 3 indicators for clues
One interesting debate going on right now among market participants, is whether the current rally in risky assets (Equities in particular) is going to be sustainable. The US S&P 500 for example, has rallied more than +36% from its March 2020 lows. Closer home, the SA Top 40 Index has run by at least similar margins since the March 2020 lows.
Market participants who are optimistic are arguing that with economies around the world gradually re-opening after the Covid 19 induced shutdowns, companies and factories will re-open, aggregate demand should increase, thereby fuelling the wheels of the economy back to full production. It is also the belief amongst this group of market participants that a vaccine for Covid 19 will be developed soon; with many pharmaceutical companies around the globe currently at various stages of testing/trialling possible vaccines.
There are however market participants who remain cautious of the recent rally in risky assets. With a myriad of negative economic data from all over the world coming out every day, it is the belief among this group of market participants that the market is way too detached from economic reality, and that the serious damage that Covid 19 has caused to the global economy is somewhat not being priced enough into the markets.
So, the big question remains, “Is the market getting too optimistic too soon”? or Is the market getting complacent?
To make sense of it all, I’m going to look at 3 different indicators and/or factors in an attempt to answer that big question.
#1. The Put/Call ratio
The put/call ratio is typically a good and reliable measure of understanding investor sentiment.
A falling ratio below 0.5 is considered bullish, meaning more ‘calls’ are being bought versus ‘puts; whereas a rising ratio above 0.7 indicates investors are buying more ‘puts’ than ‘calls’.
A look at the current Put/Call ratio, shows a ratio of 0.5, which is (historically) considered low, meaning investors are buying more calls than puts; which I interpret to mean investors don’t really feel the need to protect their Long positions and are comfortable that prices are going to continue rising.
While there is nothing wrong with being positive about prospects of the economy, recent data releases suggest that Covid 19 has done and/or is going to do more damage that what the market has or is pricing in.
While the race for finding a vaccine is ongoing, there is still a lot of uncertainty of when it will be ready for use, and how much more damage the pandemic would have caused by then.
Also, looking at the massive unemployment levels that economies are going to have to deal with after the pandemic is over, it is difficult to see where current bulls are seeing aggregate demand coming from to justify the current market rally.
The fact that investors are confidently getting long without any ‘insurance’ as evidenced by the current Put/Call ratio leads me to conclude that the market may be getting complacent.
#2: Technicals just don’t look convincing
Looking at the S&P 500 daily chart, for example, it shows that bulls still need to do more if they are to sustain the current rally. Price is currently at the late stages of a bearish rising wedge technical formation. Price is also flirting with the 200-day moving average. What this tells me is that the current rally may not last longer and a pullback may be imminent.
Locally, the SA Top 40 Index doesn’t look convincing either, as a somewhat similar technical chart pattern has developed. Last week we traded into the 48,000 previous support (now resistance) zone, and we saw a rejection off that level. For as long as price remains below that 48,000 resistance level, as well the 50- and 200-day moving averages; I got to say, the odds of a break lower remain high.
#3: US-China Trade tensions
Another factor that I believe the market is under pricing is the US-China trade tensions. Already they are clues that either parties may not be able to meet their part of the bargain on last year’s trade deal.
Knowing the kind of volatility and damage that these trade wars caused in the past, it is difficult to imagine how the market will ignore them should they resume. As such, I remain cautious of the current rally in risky assets, and I am of the view that, by not pricing in these geo-political tensions, the market may be getting complacent.
What to do in these conditions?
As difficult as it is to pick a direction of where things might go in the short-medium term, opportunities are always there for investors and traders to take advantage of.
One thing that is almost certain amid all this uncertainty, is that volatility is going to be around for quite some time, regardless of whether the risky assets rally continues or not.
At Unum Capital we offer a wide variety of instruments that traders can take advantage of amidst all this volatility. One instrument that is particularly eye catching at the moment is the Volatility Index, popularly known as the VIX.
Looking at the Daily chart below, VIX looks ‘cheap’ at current levels, and traders may want to consider a long.
Here is what Unum Capital Trading Desk Analyst Lester Davids, had to say about the VIX at current levels:
“Volatility is still cheap. With political tensions rising, and equities being priced for an endless stream of liquidity, I think it would however be prudent to exercise caution at this stage….. As volatility potentially rises, and as incoming data gets digested into risk assets, we think that investors should be able to profit as volatility returns.”
There are a couple of instruments that investors and traders alike can make use to trade the Volatility Index, which include the iPath VIX ETN (Exchange Traded Note).
Get in touch with us today and let us guide you on how you can profit from the potential rise in volatility.
Until next time, let’s keep it profitable in this ‘complacent’ market.
Head: Unum Capital’s GetSelected Division