As Fear Stalks Market, Bulls Often Follow

As Wall Street opens today after last week’s horrendous losses, some widely followed measures of investor sentiment show that people now feel extremely bearish about stocks.

But in the odd ways of Wall Street, that may actually be a good sign for the market’s short-term prospects.

Historically, extreme levels of both bullishness and bearishness often have marked turning points for stock prices. In other words, just as investors feel the most sullen in the midst of a harrowing downturn, the market often reverses course and rebounds.

Likewise, the market often has topped out just as investors have been their most ebullient.

Near the end of last week--which saw the U.S. market’s worst weekly decline since 1989, with the Dow Jones industrial average falling 481.97 points, or 5.7%, to 8,051.68--two key sentiment indexes neared their most bearish levels of this decade.

* The ratio of “put” buying to “call” buying for stock options on the Chicago Board Options Exchange reached 0.616 in the 10 days through last Thursday, the highest level this year and not far from the 1990s peak of 0.655 seen in October, 1990.

A put gives the holder the right to sell stock at a set price in the future. So investors buy puts when they think a stock will tumble. A call, on the other hand, gives the holder the right to buy stock at a set price in the future, and thus is a bet that the stock’s price will rise.

A high put-to-call ratio, therefore, shows growing conviction that stocks are headed lower.

Historically, a 10-day average put-to-call ratio above 0.5 has indicated widespread bearishness. The ratio’s October 1990 peak coincided with the ’90 bear market bottom.

* A survey of market and commodity newsletter writers by Market Vane in Pasadena showed the percentage who are bullish on stocks fell to 31% late last week, down from 73% in mid-July.

The bulls’ ranks have slumped to near the 1990s low of 26% reached in April 1994--which, coincidentally, was the low for blue-chip stocks in the 1994 market pullback.

Why are extremes of bearishness and bullishness often “contrary” market signals?

The most common explanation goes like this: By the time that bearishness reaches excessive levels, investors are thought to have completed most of their selling. That also leaves many investors with hoards of cash that can quickly be funneled back into stocks at the first sign of a turnaround.

Conversely, when investors feel overly rosy, they’ve probably put most of their free cash into stocks and thus have little left with which to power stocks higher.

Some Wall Streeters are surprised the market hasn’t rebounded already, given the recent surge in bearishness.

“That’s a big concern because we’re at some key technical levels,” said Robert Rack, vice president of research at Schaeffer’s Investment Research in Cincinnati. “We really need to bounce here.”

But others say that, given the crisis rippling through financial markets worldwide, U.S. stocks have to fall further--and bearishness must worsen--before the market can regain its footing.

They point out that while some sentiment indicators are flashing “oversold” readings, other yardsticks aren’t quite so bearish.

A weekly survey of independent investment newsletters by Investors Intelligence in New Rochelle, N.Y., shows the percentage of bullish newsletters dropped only slightly last week from the previous week, to 40.4% from 40.7%. The bearish percentage rose by a greater amount, to 38.6% from 34.5%.

But bullishness would have to fall more--and bearishness rise more--to signal a market turn, according to Investors Intelligence’s data. Historically, the bulls must fall to 35%, and the bears reach 50% for sentiment to be considered bearish enough to signal a market recovery.

“Right now, we’re moving in the right direction to point to a market bottom, but we’re not there yet,” said John Gray, co-editor of Investors Intelligence.

Market-wide, “there has been enough damage done to create oversold conditions, but the bearish sentiment doesn’t seem to be enough to bring about a turnaround in the market,” said Rao Chalasani, strategist at Everen Securities in Chicago.

Besides its fundamental problems, the market is about to enter September--which historically has been its worst month of the year.

Though October is notorious because of the market crashes that occurred during that month in 1929 and 1987, stocks have fared worse, overall, in September.

In the past 50 years, blue-chip stocks have dropped an average of 0.5% in September, while they averaged a 0.1% gain in October, according to Logical Information Machines, a data and research firm based in Chicago.

Experts have struggled to figure out why the market fares so poorly in September. Conjecture ranges from families withdrawing funds for tuition expenses to the psychologically dampening effect of daylight hours shortening.