During the last two months we have seen selling in the U.S. equity market.
From the May 1 high to the June 16 low, the S&P lost just more than eight percent. While not a huge pullback, it was a slow and methodical one and it allowed the S&P to move out of overbought territory and down to the most oversold it has been since March 2009, at least based on the 10-week slow stochastic readings.
This is good news for the long-term investment horizon as the index had been overbought for some time.
The other piece of good news is that the pullback has caused the sentiment toward the overall market to shift from extreme levels of optimism to extreme levels of pessimism.
One indicator in particular that I was encouraged by was the CBOE Equity Put/Call ratio and its 21-day moving average. The indicator measures the number of bearish puts that are traded versus the number of bullish calls that are traded for any given day. This particular ratio only looks at individual equities and doesn’t look at index options.
On June 17, the 21-day moving average for the indicator hit 76.71. This is the highest (most bearish) this indicator has been since the low in March 2009.
From a contrarian standpoint, extreme levels of pessimism like this are a good sign that a rally is close at hand.
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