After a three-month 40 percent rally in the S&P 500 (.SPX) from early March to mid-June, many indicators suggested investors had become more optimistic, bullish, and even a bit complacent. However, the S&P 500 fell about 2.5 percent Thursday and is down 5.2 percent since June 11. Like a pendulum on a grandfather clock, sentiment has been shifting and a number of indicators now suggest that levels of anxiety and bearishness are on the rise. The shift is noteworthy, as it follows relatively quiet trading in June and ahead of a seasonally weak period for the equity market during the month of July.

Investors Intelligence reports that bullishness declined and bearishness rose for a third consecutive week. Their historically reliable survey of investor attitudes now indicates that 41.4 percent of those surveyed are bullish, down from 43.6 percent last week and 47.7 percent three weeks ago. Bearishness rose to 29.9 percent, up from 26.4 percent the week before and 23.3 percent on June 10.

The ratio of puts to calls traded on the exchanges is on the rise. Thursday, for example, saw a nearly equal amount of put and call activity, or a ratio of 1.00. The ten-day average is plotted below. After falling to extreme lows of .73 in late May, the ratio is back to .86. The fact that investors are increasingly using puts, rather than calls, is often a sign that bearishness is on the rise.


Total put-to-call ratio (10-day Average)

Shifting sentiment is important. After the market crash of 2008, investor confidence had been lost. Pessimism had reached an extreme and, only once some confidence had been restored, could the equity market begin to move higher. Beginning in March 2009, falling levels of negativity and increasing optimism turned into a self-feeding cycle that sent the S&P 500 up 40 percent over the course of three months. That trend continued in May. AMG Data reports that mutual funds saw net inflows of $21.4 billion in May, confirming that money was still flowing into equities. However, that trend has changed and AMG Data also reports that equity funds saw net outflows of $6.1 billion during the final two weeks of June.

Trading was very quiet last month. The average daily move in the S&P 500 was only 7.7 points, about half the price swings seen during the first five months of the year. Yet, despite the quiet market action, it appears that risk perceptions and bearishness are beginning to rise. What happens to investor sentiment if volatility really picks up and stocks move lower? Does it turn into another self-feeding and bearish cycle? The market action next week, after Thursday’s 2.5 percent in the S&P 500, could be the first indicator of sentiment going forward. Will investors “buy the dip” or is the volatility going to trigger another wave of selling?



Importantly, the month of July has been a historically bearish and volatile month for the stock market in recent years. The S&P 500 has lost ground during the month of July during 7 of the past ten years. The average loss is 3 percent. Traders should prepare for the possibility of higher volatility in July and look for specific opportunities and situations to make money on the downside. We do this by tracking order flow in the options market and finding areas where “smart money” is taking positions in anticipation of volatility. Of course, we look for bullish opportunities as well. New ideas are highlighted daily in our blog and more frequent updates are provided in WhatsTrading.com Premium.