Nothing to Fear but the Fearlessness

Although investors' views aren't as rosy as they once were, it's too early to tell if this market has bottomed.
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Warren Buffett hasn't gotten a lot of respect lately, but something he once said gets to the heart of the market's current problem: "We're scared when everyone is greedy. We're greedy when everyone is scared."

Greed was certainly in ascendance this past winter and fall -- at least in the technology, media and telecom names that have come to be called, variously, TMT or New Economy stocks. From its Oct. 18 low to its March 10 high, the

Nasdaq Composite Index

gained in excess of 87%. It was a phenomenal run, one that drew even naysayers into its updraft.

When

Merrill Lynch

did its monthly poll of fund managers in March, it found that U.S. professionals were heavily invested in technology and communications services, despite twice as many believing these stocks were overvalued as those nonbelieving. Cash positions were low.

The April poll, released Tuesday, showed how much things have changed. Technology, though still loved, was not as loved as financial stocks. Communications stocks were no longer in the running. "They're moving away from the growth cyclicals and moving toward defensive stocks and things like pharmaceuticals," notes Merrill global strategist Owain Evans. "They're raising their cash positions."

In short, the fund managers have gotten more bearish -- and not just in word, but in deed. In the world of Wall Street, that is a good thing. It suggests that people are beginning to get scared and, as Mr. Buffett said, that's a good time to get greedy.

The problem, however, is that people were so incredibly bullish. Although sentiment has worsened, investors are still quite positive.

"They are getting more nervous, but only on a relative basis," says John Bollinger, president of

EquityTrader.com

. "There was tremendous bullishness in the system. It's going to take quite a while to work off that severe overbought reading."

Bollinger and a lot of other market watchers have been paying careful attention to the options arena and the ratio of puts to calls. A put makes you money on the way down while a call makes you money on the way up.

In the contrarian world of market sentiment, the higher the put/call ratio the better, because it means that if enough investors are aware of market weakness and seeking protective puts, that the end surely must be near. That, in the past, has made this ratio a good way to judge market sentiment.

At the market bottom in the fall of 1998, and again this past fall, the put/call ratio spiked higher, marking the severe negativity that had come into the marketplace and, as it turned out, excellent buying opportunities.

Where's the Fear?
Equity Puts vs. Calls

Source: McMillan Analysis

Yet, nothing like that happened in the recent selloff.

"When we saw that big plunge a week ago, we didn't see any corresponding increase in demand for puts," says Todd Clark, head of listed trading at

W.R. Hambrecht

. "That's a big problem."

It suggests that, despite the big tech selloff, the fear that often marks the best buying point has yet to come. And that seems to correspond well with the general sense among Wall Streeters of how things are going.

"There's always been a great deal of optimism in these stocks, and I'm not sure that there's been a wholesale dumping in the issues," says

Weeden

market strategist Steve Goldman. He notes that Nasdaq volume has lightened considerably, belying a general lack of interest in buying techs. "After the bottom-fishers come in, and you've had a bounce, who's going to take the ball from there?"

Yet if Wall Street is worried, it is even more confused. The differences in stock performance are severe. Although the Nasdaq is nearly 20% below its highs, the

NYSE Composite

-- the Nasdaq's Big Board counterpart -- is approaching last summer's highs.

In a market where stocks in general no longer move up and down with each other, it is unclear whether indicators such as the put/call ratio are valid. It does not help that recent volatility has made put options on Nasdaq stocks prohibitively expensive.

If there is a problem in the stock market, it may be that uncertainty itself. When money constantly shifts from one sector to the next, and then back again, it's hard to know where to put your chips.

"People just don't feel like they can figure out what's going on," Clark says. "Until you can get this rotational psychology out of the market, I think it's going to stay very, very choppy."