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Already at progressively higher all-time highs, U.S. stocks received an extra boost on Monday after a report surfaced that the U.S. will remove China from its list of currency manipulators. The label was unceremoniously placed on China by the U.S. Treasury Department last August amid escalating trade tensions between the two countries. Since then, tensions have eased dramatically, and negotiators from both countries are slated to sign a “phase one” trade deal later this week.
This bit of market-positive news on the U.S.-China trade front comes just as volatility stemming from political and military conflict between the U.S. and Iran within the past week has cooled. Although geopolitical and trade risks certainly remain, the significant easing of tensions for the time being has propelled substantial market moves. These include a continued surge in equities, a significant lull in market volatility and put-buying, and sharp pullbacks in both gold and crude oil, which had recently rallied due in part to the U.S.-Iran conflict.
Below is a comparison chart of three major U.S. indexes — the S&P 500 large-cap index (represented by the SPY ETF), the tech-heavy Nasdaq 100 index (QQQ ETF), and the small-cap Russell 2000 index (IWM ETF). This comparison starting at the beginning of 2019, or slightly over a year, illustrates how large-cap technology stocks have excelled while small-caps have lagged, despite the sharp rally in the Russell 2000 since early October.
Lull in Put-Buying
The put/call ratio is a simple formula comparing the trading volume of put options to call options. Generally, put options are considered an expression of bearishness for options buyers. Conversely, call options are considered an expression of bullishness for options buyers. Of course, this is not always the case, as options can be traded for many other purposes than just speculating on market direction. Options can also be used to generate income, provide insurance, or to hedge underlying positions. But the most basic function of measuring puts to calls is to express sentiment.
To derive a put/call ratio, simply divide the number of traded puts by the number of traded calls. If there are more traded puts than calls (generally considered bearish), the ratio will be above 1. And if there are more traded calls than puts (generally considered bullish), the ratio will be below 1. Keep in mind, though, that when the ratio goes to extremes, it can often be seen as a contrarian indicator that may hint at an impending reversal in sentiment. The CBOE’s put/call ratio provides an overall view of market sentiment for U.S. stocks, ETFs, and indexes.
As we see on the current chart of the CBOE’s put/call ratio, the reading is at a low 0.773, which suggests that put trading is at or near a relative low when compared to its historical range. This gives an indication that there is considerable complacency in the equity markets as stocks hit new record highs. While the ratio is not quite at the extreme lows of the past few months, it’s not far off, and it has generally been trending down since late last year. On the flip-side, any other news-driven market tumble will likely cause a very substantial spike in the put/call ratio.
Crude Oil Tumbles
As U.S.-Iran tensions have cooled down, at least for the time being, crude oil prices have come back down sharply after having hit a new eight-month high last week on the intensifying conflict between the two nations. Although crude has certainly pulled back sharply in the past several days, U.S. tensions with the Middle East are likely far from over. If this is indeed the case, we could be seeing significantly more upside for crude oil prices.
Gold Buyers Take a Breather
Gold has been on an absolute tear in the past month as market risk concerns have helped boost the precious metal in its capacity as a perceived safe-haven asset. Investors tend to buy gold when they are concerned or fearful about global political and economic conditions.
Gold prices reached a new peak last week, hitting a new six-plus year high on the U.S. conflict with Iran, before coming back down in the past several trading days. Also helping to buoy the precious metal has been prolonged low interest rates and a relatively weak U.S. dollar. But in the absence of major geopolitical risks, gold prices have less of a reason to spike. For the time being, at least, the downturn in gold looks poised to continue until another news-driven shock potentially results in another surge.
The Bottom Line
As the S&P 500 and Nasdaq Composite hit new all-time highs on Monday, options put-buying continued to languish near range lows, gold prices fell further, and crude oil continued to plunge as geopolitical tensions cooled. While all of this bodes well for a continued bull market in equities in the near term, risks and tensions remain that could well be poised to disrupt the strong bullish trend.
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