Trader’s Narrative

More than a year ago I called it: We are in a recession!

It was rather foolhardy to go out on a limb like that but with the help of hindsight we now know that that was quite a prescient call. What I didn’t expect was that we would be entering one of the most serious recessions we’ve seen in recent history.

Since the National Bureau of Economic Research has been keeping track of them, we’ve had 22 recessions (including this one). However, only 4 have been longer in duration:

Source: Chart of the Day

It may be just as foolhardy to now do an about turn and declare that the ‘Great Recession’ is over. But we are seeing some indications of that. The bad news is that the sharp contraction in inventories that we’ve seen has been unprecedented in recent economic history. The good news is that such drawdowns have historically signaled the end of recessions:

Souce: Doug Kass at theStreet.com

When the market started to take a dive, the vast majority of the usual technical indicators started to blink green, one by one. The one that didn’t and has arguably continued to refuse to cooperate with a bullish scenario is the options market. And more specifically, the difference flavors of put call ratios. First I’ll go over the data and then try to provide some explanations. If you have a better one, by all means, drop me a comment.

Week after week, as the markets plummet headfirst into an abyss, the options market confounds everyone by reflecting no fear, not even rational caution. For example, on September 19th the waterfall decline we’ve experienced so far was still to unfold but the CBOE equity only put call ratio went to 0.62 - the lowest it has been in a month.

From then on things just went from weird to strange to downright confusing. On the same day as the CBOE put call ratio was putting in that strange performance, the ISEE Sentiment Index which is a different measure of the options market, fell to 66 - showing significant fear (although not extreme according to its history). Then just a few days ago, on October 20th the ISEE Sentiment index actually rose to 146 - meaning that retail traders were shunning puts and flocking to calls!

To be fair, for two consecutive days (September 9th and 10th) the put call ratio spiked higher than 1.0 But when you consider both the speed and depth of the market’s fall (more than 40% from the 2007 October highs) it is astonishing that we have not seen a mad dash to buy puts as we have in every single bear market decline in recent history, pushing the put call ratio much higher and sustaining it above 1.0 for a full week or more.

So what is going on?

The most obvious explanation is that because of the astronomical volatility, options are extremely expensive. So Joe Sixpack or Joe the Plumber thinks twice about buying put protection for his portfolio. Or just doesn’t and hangs on for dear life. Here are some other explanations:

Michael Kahn
One explanation, offered in Barron’s Getting Technical column is that the government ban on short selling of financial stocks (quickly amended to include others as well) not only threw out the normal balance of the options market, but also skewed the VIX index, propelling it to unheard of levels. But wouldn’t the ban on short selling have meant that people would be creating synthetic short positions (selling calls and buying puts)? or just buying puts?

Helene Meisler
Helene Meisler is the technical analyst savant at thestreet.com where she has been, unfortunately, put behind a subscription wall. I’m not sure if she has already written about this in her The Street columns but according to her what we are seeing in the options market is par for the course for a true bear market. She explains that in a bear market, people are forced to liquidate everything, even their winners. So there’s nothing for them to protect via puts. They then may buy puts outright believing the market’s going lower.

Jason Goepfert
Jason Goepfert of SentimenTrader explains that it is not unusual to see a mismatch between the put call ratio and a true bottom. Historically the market has bottomed out a wee bit after the options market indicated massive fear.

At the same time, he also notes the effect of the short sale ban saying that some brokers had not been allowing their clients from exercising put options unless they already had the shares in a long position.

Apart from the ISEE sentiment index and the CBOE put call ratios, Jason provides his own measure of the options market: the ROBO ratio. Right now it is in agreement with the other options metrics, indicating no real concern on the part of small retail options traders. Amazingly enough, they were much more scared during the market decline in March 2008.

Silver Lining
I don’t want to make a mountain out of a molehill but even after considering the whole short sale ban, the options market has been behaving in a very uncharacteristic way. The only silver lining I can see around this confounding cloud is the way the OEX option market has been going. It is preferred by the “smart money” so it is not interpreted as a contrarian indicator.

We’ve gone quite a while without a financial journalist or commentator taking a swipe at Jim Cramer. Before we get to the most recent one, lets not forget an earlier one.

Blodget vs. Cramer
At the beginning of the year Henry Blodget wrote a scathing article on Slate: Pay No Attention to That Crazy Man on TV. Yeah, that Henry Blodget (Amazon.com $400/share). Cramer, as you can imagine, didn’t agree and came out punching.

Blodget’s indictment of Cramer in sum:

..the essential conflict in the American financial industry: the war between intelligent investing (patient, scientific, boring) and successful investment media (frenetic, personality-driven, entertaining).

To be fair, Blodget did make a huge mistake but he also paid a dear price. In the end, he not only gained wisdom but also humility. Cramer on the other hand lives in a reality of his own making where by filtering and editing history, Cramer is always right.

It is easy to make fun of Blodget for believing the hype but if you think he was the only one who bought wholesale into the mania, take a look at this giddy speech that Cramer gave at the top of the bubble.

Farrell vs. Cramer
Farrell is a commentator on MarketWatch.com - he has wisened with age but sometimes can come across a tad cantankerous. His main critique is the frenetic pace of the “advice” that Cramer imparts (a staggering 3,000 in just the last 3 months) and the opportunity cost of researching stocks and trading (transaction costs plus taxation).

Cramer’s retort is flimsy:

What really gets to me is an assumption that Farrell made without any justification about the people who regularly watch “Mad Money,” although he’s hardly alone in this. It’s the idea that the people who watch the show are idiots who thoughtlessly buy the stocks I recommend without taking any of my actual advice to heart.

For one, Farrell is saying that following Cramer’s advice of “doing homework” simply isn’t practical for the average Joe. And even if he were to do it, the opportunity cost makes it a losing proposition.

But more importantly, how can Cramer not notice that whenever he mentions a stock his viewers causes a spike in its price? That many times people are so excitedly tripping over their keyboards that they sometimes transpose symbols or buy similar sounding stocks sending other companies’ stocks for a short and bumpy ride?

Shouldn’t they be frantically researching the stock instead? For an hour?

This is a clip of Jim Cramer on Conan. I think its from August 2005 so its not recent. But it is hilarious. It is only 4 minutes long so don’t miss it.

Who do you want to get stock information from?
A guy in a diaper…

This may get the Mad Money fans riled up but I don’t really think much of Cramer. The guy is all schtik, no substance. And please don’t tell me he was a hedge fund manager who made money.

He worked with some very good traders. Todd Harrison for example. And as he calls her “the Trading Goddess” (his wife) who single handedly saved his butt in 1987 when he wanted to pile on long. She was the one that flipped the fund short before the crash and made them some major ching.

The only reason Cramer made any money was because back then there wasn’t Regulation FD. He’d get calls from investment bank contacts with upcoming changes in coverage for stocks (upgrades/downgrades). He would reward them by routing trades through their brokerage arms. How hard is it to trade with that kind of advantage? Any wonder then that he riled against Reg FD as it was proposed and going into effect?

To see how he’s done in a post-Regulation FD environment, check out his abysmal performance in his thestreet.com picks. Even in a bull market he performed very poorly.

Finally, if you haven’t seen this yet, check out how vehemently he believed in the bubble.

Today (until midnight), courtesy of Dow Chemical (DOW), you can take a peek inside the subscription only side of The Street (RealMoney.com).

I would especially recommend the following writers:

Helene Meisler
Tony Crescenzi
James Altucher
Doug Kass