Friday, December 31, 2010

The one thing that is genuinely, inexplicably, pound-the-table, cheap right now

I haven't been mentioning it every day, but the CBOE equity put/call ratio is still really low - the 20 day moving average is  ~two standard deviations below the mean for the past three years.

These sentiment extremes can last a maddeningly long time, but not forever. It's hard to be short now, but there really isn't a choice.

If not now, when? To put it another way, what if you could dream up a wish list of conditions for a perfect shorting opportunity?

It would have extremely high retail sentiment, a Chinese market starting to falter, very low NYSE short interest, investors believing that inventory restocking is permanent, an S&P dividend level in the bottom 10th percentile since 1880, extremely low implied volatility, another internet bubble, a "buy the dip" mantra, insolvent states that no one cared about, USA Today telling you to get back into stocks, a market that qualifies as one of Hussman's Who's Who of awful times to invest: overvalued, overbought, overbullish, and with rising yields, high levels of margin borrowing, a Federal Reserve chairman who sweats bullets in media interviews, an ISEE Sentiment Index hitting 52 week highs, cocky bullishness from fund managers with terrible 10 year track records, a return of the broken window fallacy, high levels of insider selling, a consensus that you can't "fight the Fed", no serious attempts to actually fix broken institutions, investors who mistakenly believe that inflation would be bullish for equities, etc.

Good investors like to buy things when they are cheap. Buying things when they are not cheap leads to unpredictable outcomes, with a distribution that contains a heavy weighting of pain.

I can think of only one thing that is genuinely, inexplicably, pound-the-table, cheap right now: volatility.

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