What Now?

The wafer thin veneer of an economic recovery, peddled by the mainstream media, is melting away. Europe, regretfully is pretty much dead in the water and starting to decompose into political extremism. The far right, far left, separatist and anti European parties are mushrooming everywhere on the continent. France, Italy, Greece, Cyprus, Portugal economies are in a deep recession, or depression with chronic unemployment. The economic engine of Europe, Germany, is stalling with its economic forecasts being regularly revised downwards. The latest revised down forecast for economic growth in Germany this year is 1.2 percent and 1.3 percent for 2015. But at the rate that things are deteriorating that is likely to be revised down again sometime in the future, maybe next month or next quarter? The contagion is now spreading across the Channel to the UK, dragging its economy lower too.

Across the pond traders are growing skeptical about the US recovery and are wonderingr whether the latest employment data showing unemployment numbers, down 5.9 percent, gives an accurate picture of the true state of the economy. Many part time jobs have replaced more stable full time jobs and some analysts believe that the data is being manipulated ahead of the US general elections, scheduled for November 4, 2014. A total of 46.2 million Americans were on food stamps, in May 2014, although the figure has improved slightly it still remains high and doesn't reconcile with the employment data.

The small business sector already senses that something isn't right. They’re noticing a slow down in sales and tight credit. Small business optimism index fell 0.8 percent to 95.3 percent, which is now 3 points below 2008 financial crisis.

So how fearful is this market?

We are seeing an unprecedented level of fear in this market that surpasses that of the last financial crash of 2008. There is no comparable event or level of fear other than the Great Stock Market crash of 1929.

How do we know that?

We can gauge the level of fear in the market by measuring the put/call ratio, which is a technical indicator that reflects investors’ sentiment, according to the Chicago Board Options Exchange’s (CBOE). The ratio represents a proportion between all the put options and all the call options purchased on any given day. Puts are options that increase in value as stocks decline. Calls are options that increase in value as stocks rise. So if traders believe that the market will fall, they buy more puts (bets the market will drop) than calls (bets the market will rise).

It is phenomenal that the recent CBOE put/call ratio of 1.53 exceeded the put-call ratios of the 2008 global financial meltdown, which topped at 1.52.

In actual fact there is no hard and fast rule for measuring sentiment. If we think about it, participants buy options to protect or hedge their portfolios and also do so to speculate on market moves. With this in mind the put-call ratio reflects a wide range of motivations and emotions. Nonetheless, it serves as a rough-and-ready thermometer of participants’ fear and panic.

CBOE ratio is available at the CBOE website. Information can be displayed in an Excel spreadsheet.

If we sort the 2,003 records from highest to lowest, we will notice that the only days during that specific time period where the put-call ratio exceeded the Lehman collapse, was on October 13, 2014, and three days in early 2007, when the first indications that the sub-prime mortgage collapse and housing bubble burst hit the mainstream media. Those three days registered the only PCRs above 1.53: 1.61, 1.65 and 1.68.

Only 28 of those 2003 days registered put-call ratios of 1.40 or higher. Only 12 days registered PCRs of 1.50 or higher. Therefore, the current level of fear (1.53) is significant.

So technically we can prove that this market is at historic fear levels, but that doesn't answer another important question. Why is this so?

This might have something to do with the fact that the market has lost confidence with the Gods, the central banks. It seems as if the central banks have fired their rounds. Quantitative easing, call it QEI, QE2, operation twist or whatever, it is done! Five and half years on and the real economy continues to remain in a quagmire (to put it politely), despite what mainstream media would like us to believe. So the central banks might have just delayed the inevitable, regretfully there is now a real risk of a full blown crash and depression ensuing. In fact, years of loose momentary policy have kept interest rates artificially low and all this has done is skewed investor perception of risks and aided and abetted another asset bubble in equities, bonds, real estate and even the classic car market.

It seems that the central bank's perpetual motion machine is broken.

But don't be surprised if we see another form of QE4 or whatever. At some point when the market looks like it is about to crash we will get a response from the central banks. Maybe the plunge protection teem will step in and do some buying, recent volatility suggest that something like this is has actually been going on. Likewise, we may see further sharp falls followed by equally sharp rises, that could just be short covering, shorters banking their profits. Either way this is a super choppy market.