Most of you know by now I’m a big fan of using sentiment tools like the VIX or put/call ratios to spot likely short-term tops or bottoms in the stock market. As you may also know, I’m a very big fan of the ISE’s (International Securities Exchange) call/put ratio as a contrarian tool. Why? It’s one of the most effective market-timing indicators I’ve observed during my too-many years in this business.

The reason I bring it up now is to tell you it says the market has not yet peaked, despite a couple of big gaps that carried stocks into what I feel is overbought territory.

Here’s the basic interpretation - when the ISE call/put ratio is at an extreme low, fear has peaked, and a bottom is likely to be in place. When the ISE call/put ratio is at an extreme high, investors are too complacent, indicating a likely top is in place. That’s the ‘contrarian’ part…going against the grain when nobody else seems to be. To really define what’s ‘too high’ and ‘too low’, I like to wrap the index in Bollinger bands (200 day).

As the chart below shows, the ISE call/put reading tagged all the major short-term bottoms. It wasn’t laser-like precision, but it was pretty close. All those lows are highlighted in yellow. The same goes for the tops, which are highlighted in blue. Take a look, then keep in reading.

See anything interesting? Despite the ridiculous rally last week, investors haven’t gotten cocky to the point of needing to be punished - at least according to the sentiment index. That won’t happen until we see a reading closer to 169. In other words, the market at these prices isn’t as terrifying as the media and pundits might have you think.

As always, no guarantees. However, the strong track record of the ISE Sentiment Index as a market timing indicator really gives me pause here….maybe there is more potential upside. Be sure to check out my other blog entry today, where I look at new lows and new highs as potential market-timing indicators.

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