Rally or No, This Market Still Looks Overbought

Isn't it just like the market to scare everybody out of it and then go straight up? Just how far can this thing go? I think I mentioned last week that the Japanese market, after collapsing early in the 1990s, was capable of 40% to 50% rallies, but no more. I believe that our market is in a postbubble environment much as Japan was, and is. It is not unreasonable, therefore, to expect that about a 50% rally is the most we can see here.

If we look at the QQQ(QQQ), which has been about the single strongest index, we see that it bottomed on Sept. 21 at 27.20. A 50% up move would put it at just over the 40 level. Today's high is 38.84, a level achieved in a blazing six-week rally.

Last fall, when QQQ made an important bottom in October, then rallied sharply in November, there was a pullback into early, mid-December. That seems likely to happen again. I have been looking for the start of such a move, but so far I feel like the economist who predicted 10 of the last two recessions.

Lately, the most accurate indicator I look at has been the mirror-image OEX put /call ratio. Here is how the indicator works: It is very bullish when out-of-the-money OEX puts are priced more than 10 times the out-of-the-money OEX calls. The puts were as much as 18 to 1 about two weeks ago, which was very bullish. They were still 5 to 1 earlier this week. That has now changed. As I write this on Wednesday afternoon, the OEX is 576 and the November 545 put is bid 2.10, and its counterpart, the November 605 call, is bid 0.90. This has to be rated as bearish. In the past, I have seen the call priced more than the put, which is quite bearish -- but that situation is very rare, and I wouldn't wait for it.

During the rally Wednesday, the OEX November 590 call was also unable to move up, even when the S&P December future was up about five points. This nonconfirmation is unusual; the OEX calls normally move up if their pricing mechanism, the S&P futures, moves up. When they don't it is often a warning sign of an imminent selloff. This, by the way, is a very short-term indicator.

The Nasdaq market has now recorded a five-day TRIN or Arms Index of 2.62, and that's very overbought. There have also been quite a few episodes of "plus ticks" above 1000 in recent sesssions on the NYSE; a high of + 1231 was seen on Tuesday. That reading is associated with a sharply overbought condition.

Here is one way I am playing my conviction that we are due for a pullback. I shorted Countrywide Credit (CCR) -- thinking the bonds had gone as far as possible and that interest rates would now turn up, hurting interest-rate-sensitive stocks. So far I'm losing 1.75, but this stock is now very extended (it ran from 39 to 46.50 in six trading days). I expect to get out of this trade alive.

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