Alcoa announced earnings last week and thus marked the unofficial open of the fourth-quarter earnings season.
With this in mind, I went back and looked at the Investors Intelligence report and the 21-day moving average on the Chicago Board Options Exchange Equity Put/Call ratio at the beginning of each earnings season over the past year.
What I found is that if history is indicative of what will happen this quarter, I would look for a correction during this earnings season.
Going back one year ago, the Investors Intelligence report showed a ratio of 0.76, meaning the bearish percentage was higher than the bullish percentage. The 21-day moving average on the put/call ratio was at 0.7176. Investors were bearish and the market rallied during earnings season.
In January when Alcoa kicked off earnings season, the Investors Intelligence ratio was at 1.7, and the 21-day moving average on the put call ratio was at 0.695. Not overly bearish, but still leaning that way and the market rallied in the first quarter.
In April, the Investors Intelligence ratio was at 2.23, and the 21-day moving average had fallen to 0.612. Sentiment was overly bullish and we saw the market fall in April and May.
In July, the Investors Intelligence ratio was at 1.73, and the moving average on the put/call ratio had jumped to 0.72. The sentiment was in the process of shifting out of an overly pessimistic state at the beginning of June and the market rallied in the third quarter.
That brings me to last week's readings. The Investors Intelligence ratio is at 1.83 and on its way down from the 2.23 reading we saw three weeks ago. The 21-day moving average dipped all the way down to 0.623 on Oct. 4.
The fact that the sentiment indicators are coming off overly optimistic readings leads me to believe that the market will struggle during this earnings season.
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