The stock market hit a number of new records last week related to exuberance.
This chart, for example, shows the S&P 500 in orange, and shows the equity put/call ratio in purple:
A call option is a speculative instrument that lets someone gain price leverage to the upside, and is often used to express a bullish view on the market.
In contrast, a put option is a speculative instrument that lets someone gain price leverage to the downside. They’re used to express either bearish outlooks, or to hedge otherwise bullish equity positions.
The put/call ratio is a measure of how much volume there is for one contact or the other. Usually, right near bear market bottoms, investors get frightened and buy a lot of put options. And equally, during the top points of major bull markets, investors get excited and buy a lot of call options. This is ironically the opposite of what they should be doing at those moments, in hindsight.
Therefore, it ends up being a contrarian signal; when the put/call ratio is high, it tends to be good for the forward prospect of stock prices (market potentially hitting a bottom), and when the put/call ratio is low, it tends to be a bad prospect for stocks (market potentially hitting a top).
Likewise, the percent of NYSE volume that consists of small traders buying call options is off the charts:
There are various threads on social media where young investors are plowing stimulus checks into call options or shares of highly-valued stocks. With little else to do during lockdowns, trading volume among retail investors is at record highs over the past year.
It’s a concerning trend, and investor prudence is warranted here.
Here’s a custom economic heatmap of how the economy is doing. Each column represents a different economic indicator, and it shows the past five years worth of year-over-year percent changes in those indicators:
From left to right, the indicators are real GDP, industrial production, retail spending, construction spending, capital expenditures, exports, imports, payroll numbers, the 10 year minus 3 month Treasury yield curve, and the consumer price index.
Retail spending, construction spending, and capital spending have been relatively strong lately. The yield curve is also looking bullish. On the other hand, payroll numbers have been the weak area, as the number of people employed is much lower than it was a year ago, and not recovering in a “V” shape:
It would be a good time to ensure that your portfolio is diversified in such a way that is appropriate for your unique financial situation.
The G Fund is Underperforming Inflation
If TSP investors leave money in the G Fund, it is guaranteed not to lose money nominally, but slowly chips away at purchasing power at current rates. On the other hand, if they invest heavily in the equity funds, they have more upside exposure, but also a lot more volatility risk.
Lyn Alden is a financial writer and an engineer, and holds a bachelor’s in engineering and a master’s in engineering management, with a focus on financial modeling and resource management. She specializes in analyzing and presenting financial data. Her investment work can be found on LynAlden.com.