The TSC Streetside Chat: Bernie Schaeffer of Schaeffer's Investment Research
By Dan Colarusso
Associate Editor
3/17/01 8:00 AM ET
URL: thestreet.com
Bernie Schaeffer, head of Schaeffer's Investment Research, combines technical and fundamental analysis with sentiment study to reach what he calls Expectational Analysis. Primarily a contrarian investor and market timer, Schaeffer publishes the Options Advisor newsletter and runs his own investing Web site.
Schaeffer, whose methodology is the basis of a chapter in New Thinking in Technical Analysis: Trading Models from the Masters, also wrote The Option Advisor: Wealth-Building Techniques Using Equity & Index Options.
Schaeffer's recent commentary has focused on the fact that, despite the recent carnage in the market, sentiment indicators aren't showing enough fear to indicate that a bottom is near. TheStreet.com's Dan Colarusso took some time last week to chat with Schaeffer about what sentiment is telling him is in store for investors.
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TheStreet.com: How did you come upon your approach and what kind of signals do you look for in terms of sentiment?
Bernie Schaeffer: My basic approach was developed over the years really through some unsatisfactory experiences I had with so-called traditional analysis, and fundamental approaches to trading.
What I found was that I would read prominent financial publications and get all excited about a situation that was mentioned and then find it didn't necessarily lead to a good trading result.
With technical analysis, I found a big gap in terms of trying to pick stocks in strong uptrends, in trying to differentiate from ones that will continue to have good charts and the ones where you'll be the last sucker to come in. I began doing a lot of studying in the options market, looking at puts, calls and strategies in trading options, and began to see certain patterns in the market that intrigued me.
One was the traditional contrarian approach, so that people betting on a stock through call options is a good contrary bet. When there's too much money committed to a stock, the concern becomes, "Where's that next dollar going to come from to keep that stock in the uptrend?" It doesn't mean it's a top, but it can mean there's some vulnerability created.
TheStreet.com: What two indicators are you watching now?
Bernie Schaeffer: I'm looking at the equity put/call ratio's 21-day moving average. [The equity put/call ratio is the number of put options that trade each day divided by the number of call options that trade each day. The ratio excludes options on broad market or sector specific indices.] In that analysis, we're looking for extreme levels, with the idea that when investors are betting too strongly in one particular direction and that bet gets to be at or near historical extremes.
If people are getting extremely pessimistic [by buying puts], that would give you the feeling that a market bottom could be around the corner because there's excessive bearishness and, by implication, an excessive amount of money has moved to the sideline. Those are situations conducive to a market bottom.
It's important to measure the sentiment relative to what the price action is. Right now, we expect there to be negative sentiment; the trick is really finding where the extreme is.
Also, I'm watching the Chicago Board Options Exchange Volatility Index. On Friday's [March 9] pullback, the thing couldn't get above the 30 level. In 1998 [when the market fell], the VIX was in the low 60s.
So now we're actually seeing some level of complacency.
TheStreet.com: How should investors be reading this?
Bernie Schaeffer: The point is that the figures are what the figures are. It's certainly of concern when someone is trying to call a bottom based on sentiment. Right here and now, it ain't around the corner. A bottom call isn't around the corner.
For that to happen, we'd need huge one- or two-day spikes on the Volatility Index from the mid-30s to 55 or 60 The way it is now, the VIX moves higher, but doesn't spike higher. When you have a rally a little bit, you get complacency. The behavior is kind of reversing as far as the speed of how it moves. That concerns me.
TheStreet.com: Is there a number in P/C ratio that can show a bottom?
Bernie Schaeffer: My feeling, based upon what I'm seeing, is that you probably need to get into the 70s [on a 21-day moving average] to start getting what you need to get. As of Thursday, the 21-day moving average of the equity put/call ratio is in the mid-60s, and I think it needs to get to the mid-70s for a bottom in a bear market.
We might also be seeing a pattern of higher lows in the put/call ratio. In the bull market period, that came in the mid-30s. Now lows are getting higher, and you can argue that the highs need to get higher because we've moved into a bearish market environment so the put/call ratio has to get more bearish for it to be meaningful.
TheStreet.com: So what will show investors there's adequate fear in the market?
Bernie Schaeffer: We need that climatic surge in the VIX or the put/call ratio. Unfortunately, what's been happening in this particular environment, instead of this climatic surge in negative sentiment, it's getting more negative in a slow bleed kind of way.
It's not working the same way it worked in the 1990s; it's much more ambiguous. That's one of the things that quite frankly concerns us.
There is negative sentiment out there, but it's no longer a slam-dunk to say that because sentiment is negative we're going to bottom. If you flip from bull market to bear market, the bar gets raised [on how much bearish sentiment you need to show a bottom].
TheStreet.com: Are there any sectors at extremes?
Bernie Schaeffer: I would remain clear of technology. Price action is horrible. We're seeing, on stocks like Cisco (CSCO:Nasdaq) and Sun (SUNW:Nasdaq) and Intel (INTC:Nasdaq), a tremendous amount of accumulation of calls as they continue to move lower.
It comes from a combination of two factors: People buying calls expecting a rally, and a lot of call selling against stock positions people don't want to sell, which provides them only limited downside protection. They're only a little chicken -- not enough to be bearish.
The drug sector has been one where there's been a decent level of put activity, although it's run into bumps this year. It has kind of held its own -- to stick a few toes in the water might not be the most horrible thing to do. Overall, I'm not seeing a heck of a lot in the way of opportunity.
What bothers me most about some sectors -- banks, brokers, retailers -- is that I almost see them as a manifestation of the complacency that's out there. The thinking is: "I'm a money manager, and I don't want to raise cash. The Fed is cutting rates, let me get into banks or brokers." Or, "The consumer hasn't given up the ghost, let me go into the retailers."
That gives me a feeling of deja vu with what happened last year in the tech sector. First, net stocks got clobbered, then B2B [business-to-business] got clobbered, and so on throughout tech. These safe haven sectors are going to have their day to get it across the head, simply because there's going to be no place to hide before we hit a bottom. |
