Charts Show Investor Panic and a Scramble for Safety

by Anthony Mirhaydari | March 2, 2011 2:29 am

So, this is how it ends. The powerful market uptrend that has seen the S&P 500 gain nearly 30% since September is collapsing under the weight of rising inflationary pressures and political turmoil in North Africa and the Middle East. And the proof is in the charts, particularly in put and call ratios.

There are new concerns that rising food and fuel prices — both here at home and overseas — will translate into reduced earnings growth and smaller profit margins. And of course, there is the risk that sticker shock will damage still-fragile consumer confidence. I’ve written frequently about these topics over the last two months — both here at Investorplace and in my columns on MSN Money.

Everywhere I look, there is evidence that Wall Street traders don’t consider this a temporary blip; instead, they are preparing for the worst. Heading into Tuesday’s session, the most important thing has been the degradation in the measures of the supply and demand for stocks, or market breadth. In the wake of last week’s harsh market decline on February 22, there just wasn’t been a big increase in the demand for stocks like we would expect if this was a bottom to rally out of. Looking at the 500 components of the S&P 500 index, the selloff on February 22 pulled down nearly 94% of all issues with more than 94% of total volume with a loss of 11.6 net points. Total volume totaled more than 4.3 billion shares.

During Monday’s advance, only 66% of the stock moved higher on total volume of just 3.2 billion shares. The intensity just wasn’t there. You can see this in the way former high-flyers in the materials and financial sectors just barely managed to climb off their lows before being pummeled again today. And you can also see it in the way U.S. Treasury Bonds continue to perk up despite the rebound in equities — something I talked about in my last blog post.

Another thing that caught my eye is the extent by which cyclical stocks are outperforming defensive stocks in the healthcare, utilities, and consumer staples sectors. That’s not a characteristic of a healthy uptrend; but instead suggests that whatever buying demand we’re been seeing is focused on the types of stocks that outperform when the economy and the stock market are weakening.

That chart above illustrates this by showing the relative strength of the Morgan Stanley Cyclicals Index vs. the NYSE Composite Index. When the line rises, cyclical stocks in sectors like materials and energy are outperforming the overall market. This is seen during uptrends. But that’s not what’s happening now.

You can see how cyclicals are underperforming by a magnitude not seen since last summer. And before that, you have to go all the way back to the summer of 2008 to get a similar period of underperformance. This suggests that the downtrend that’s developing is significant.

It’s worth noting that the short pullback we saw in November due to the Irish bailout didn’t see a cyclical underperformance like we have now — which in retrospect indicated the pullback would be quickly resolved and the uptrend would resume.

And finally, another way to see the change in sentiment is by looking at the flood of activity in equity put options, which is now pushing up the CBOE Equity Put-To-Call Ratio trendline at a pace not seen since May. And as you can see in the chart above, the nine-day moving average has broken up and out of the downtrend channel that has held the measure for 10 month. This is a reflection of real money being put to work to protect positions against downside risk as well as make speculative bets that stocks are headed lower.

For investors, the best advice is to pull capital out of equities and park them in cash or Treasury bonds for now — which is one of the few asset classes that is showing any real strength at the moment.

Disclosure: Anthony does not own or control a position in any of the companies or funds mentioned.

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