Crescat Capital: The Put Call Ratio Is At Extreme Lows

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ValueWalk’s Raul Panganiban interviews Kevin Smith, CFA, Founder, CEO, and CIO and Tavi Costa, Partner and Portfolio Manager at Crescat Capital. In this part, Tavi and Kevin discuss the RSI chart, the put call ratio, if we are headed towards another economic downturn, and shorting the S&P 500. Check out the full interview on ValueWalk Premium.

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Raul Panganiban: So just wanted to welcome all our listeners to a very special episode. Back on the episode is Kevin Smith, CFA, Founder, CEO, and CIO of Crescat Capital and Tavi Costa, Partner and Portfolio Manager at Crescat Capital. And Kevin and Tavi. Welcome back to the show.

Kevin Smith: Thank you Raul.

Tavi Costa: Thanks for having us.

Raul Panganiban: All right. Last episode, we covered a lot of ground and the market has come back. And as everything is getting back to normal and reopening. We're approaching the same levels before the COVID crash. So I just want to begin with the S&P and one of your charts that you've shown, has the stock market at unstable technical extremes can tell me more about that?

Tavi Costa: Yes, I think you're referring to the RSI chart, in which Kevin also has combined a lot of technical indices that also show the the same sort of imbalance in the technical side. It's incredible how the macro and the fundamental side already is undeniably bearish. But at the same time, the technical side is also becoming part of it to the sentiment in our view is euphoric. I mean, we're now seeing some bears capitulating. It's time before the Robin Hood traders now trashing the in depth research of 10Ks and 10Qs and mocking Warren Buffett and investing in bankrupt companies and saying fundamentals don't matter. It's incredible how we switch from a depression sort of sentiment to now this euphoric narrative and you know, when we look at fundamentals for instance, the profit margins continue to fall apart and we don't see any any real rebound in CAPEX estimates from companies we chose the perhaps economic activity is not coming back anytime soon. Even the Fed's own economic activity index has just declined again recently, which is in total contrast with equities at record valuations, as you just mentioned, when we looked at other measurements of economic activity like restaurants, restaurant bookings, and that was just slowly moving hired or a TSA number of travellers also doing the same, certainly not the rocket ship recovery that we were told, but don't buy Trump. And so I think those are the biggest issues in the markets today that maybe Kevin can add to that, but it's certainly in our view, reminds us a lot of February it feels like we're in February, again, when market was in total disconnect with reality.

Kevin Smith: Yeah, when you talk about technicals, it's, you know, just really the insane overbought levels of this market, just how much this relief rally has taken us so so much up so so quickly to you know, in some cases to new highs and things Like NASDAQ 100. And, you know all you know, getting very close to the previous highs in the s&p 500. But it's things like the put call ratio that are at historical extreme lows. And the is the percentage of stocks above the 50 day moving average. The sheer strength of the rally over just 50 days you know, in addition to the RSI which which Tavi mentioned and tweeted about the 14 day RSI just oh extreme overbought and and certainly going along with these millennial day traders getting control of the market here recently.

Raul Panganiban: Yeah, can you tell me more about the put call ratio and what you're seeing there and you mentioned it was low?

Kevin Smith: When there's so the the CPE tracks a net aggregation of overall puts and calls on in the option market and when there is an overwhelming number of call options on the books as opposed to put it's a historically low put call ratio. And what we like to do, because that's a daily measure what we like to do, and it just looks so so like an EKG of a crazy person, we, we like to do a smoothing by by doing like a five day moving average, or whatever. So when you do a five period moving average, it kind of really smoothes it out. And you can see that it's, it's pretty much the lowest put call ratio it's ever been in history, or it was last week when we had that that market peak on on June 8. And that's kind of when we really noticed the extremes and put out those technical charts. So, so far, it was the SMP recent top. We'll see if that holds or not.

Raul Panganiban: And are we, well then, I guess, are we headed for another downturn and will that drop be steeper than the one in March?

Tavi Costa: I think It's very possible there are a lot of potential triggers out there. I mean, if you think about all the events that we've had so far this year, we started the year with U.S. and Iran almost getting in the war. And the virus pandemic began again in February. And now we have the risk of a second wave. We have the recession, the steepest economic downturn in history, and then oil prices when negative, then we have 20 million unemployed Americans with no rush to go back to work and no work to go back to. And now we have the unemployment insurance programme. it expires in July and we'll see if that's going to get extended or not, but that's going to be a big deal. And and we have a shift as well and have seen a shift on on consumer behaviour with with savings rate No, no increasing significantly now at the highest level ever in at 33% relative to disposable income. And in other situations like the US and China trade deal that are long gone. In a scenario right now and the riots, they're in protests, they're they're breaking out knit and you know, the whole country. I think there's a lot of, like I said, it really feels like we're in February again, at the same time as we have a tonne of other equity valuation metrics that we look at that are truly at record levels today wait worse than when we point out in a previous interview we had with you why because fundamentals and macro have only deteriorated and, and equity prices have continued to move higher, so stunning to us. I mean, it's kind of surprising to see the scenario after such a decline that we had in March in my view, but it you know, on the positive side, I think it's it's an incredible opportunity for any short seller to start being selective and looking for opportunities. There's quite a lot of opportunities out there.

Raul Panganiban: Would you short the S&P?

Kevin Smith: We certainly would. We're short a number of different stocks in the S&P 500. And we believe that the The stock market at large is still record overvalued, in fact, even more so than it was in February when you look at compared to underlying fundamentals for the near term future, which have just absolutely fallen apart, whether it's earnings estimates are you look at the NIPA data for the overall corporate earnings of the overall economy, including public and private companies. And we had to record overvalued measures that we were profiling we had about eight different ones of which seven were pretty much near historic all time highs back you know, back in February, and today it's all eight of them and the one the one missing one was just the absolute P/E ratio with with earnings now plunging. We have forward P/E ratios now, pretty much near all time highs as well. So We know we're short a number of different companies in the S&P 500 across a number of different industries.

Raul Panganiban: And is it better to do it that way, rather than shorting the index as a whole?

Kevin Smith: Well, we certainly prefer to do that we believe we're capable of delivering alpha, both from our macro ideas, you know, getting the S&P part of the equation, right, for instance, but also from picking individual stocks to be short. So we think we can add additional alpha by doing that.

Raul Panganiban: And for those stocks that you're shorting the S&P, what do you look for when you are shorting them?

Kevin Smith: Well, for us, we have a quantitative model that that I originally developed more than 20 years ago, that looks at about six major factor categories and 50 different underlying factors to score and rank on discord rate stocks, and they're primarily fundamental, and that's valuation criteria. But it gives us, It allows us to hone in on individual stocks. And, and so we, you know, there's basically two categories of socks that were short today. I mean, one one is, is sick, it's cyclical companies probably first and foremost that that are going to be most caught up in this current economic downturn that we're in and and that have that tend to have, you know, a lot of leverage and exposure to the economy in general. And the other is, is because we believe the overall market is overvalued and we're truly in a financial asset bubble. You know, we're all a lot of people have been flocking to growth stocks and including the you know, technology stocks and Fang stocks and software companies in particular that that will make sense in in a slowing economy that you want to pay. premium for growth stocks. But the premium that people are paying today for growth stocks is just insane. And so so we're short a number of software companies and technology companies as well.

Check out the full interview on ValueWalk Premium.