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Thursday, November 7, 2002  8:00 PM EST

It has been made clear by several subscribers that my commentary yesterday was extremely hard to understand, and trying to derive a point from it was an effort in futility.  So let me try to clarify tonight.  Market lows are very often formed in a violent fashion.  Market highs are marked by low volatility, or "complacency" as it is commonly called.  There are countless ways to measure and quantify volatility, and I presented two of them yesterday - the daily range in the S&P 500 and the daily range in the NYSE TICKS.  My point from the two charts was that although we are seeing volatility as low as the August peak, we are not yet at a point that marked most prior peaks during this bear market.  Confirming this is a low (but not extreme) VIX fear premium, which is posted to the site each day.

There's not much new to go over tonight, even with the large move in the market today.  On a short-term basis, the STEM.MR model is high, and close to its upper deviation band, but it's not close enough to generate a stage change to positive.  The price oscillators have cycled back from overbought to flirt with oversold, and considering the excellent job they have done over the past month, that is certainly a positive. 

We continue to have confusing put/call information, with an OEX 10-day MA and equity-only 10-day MA both at or near their lower standard deviation bands.  This suggest that both poorly capitalized traders (who mostly trade equity options) and their more savvy index trading cousins are either expecting more upside or limited downside.  Since these ratios typically move counter to each other, this recent development is unusual.  This weekend, I pointed out one other occurrence late last year that ultimately lead to a prolonged trading range.  Going back even further, there was one more occurrence of these ratios both being relatively low together, which was in June of 2000.  Once again, it lead to a two-month trading range (albeit a very WIDE trading range).

I've pointed out the 900 level on the S&P 500 several times recently, and that's right where today's decline stopped.  We actually bounced off 900 a couple of times, and that continues to be my line in the sand.  I rarely point these levels out, in fact the last time was back in September when I said that 875 would be so key.  In any event, above 900 I am net bullish and will concentrate on long setups until we begin to see more of a confluence of overbought sentiment extremes.  Below 900, things become much more dicey.

On a side note, I will be out of the office for most of the trading day tomorrow, so no model changes or intraday updates will be sent.  The last time I was away was the pivotal day of October 10th, so I'm sure tomorrow will prove dramatic.

Wednesday, November 6, 2002  8:00 PM EST

Near the July low, I had mentioned that the large price swings we had been seeing were a sign that a meaningful low was approaching.  As confirmation of that thought, I posted a chart similar to the one below:

This chart shows the 10-day average range of the S&P 500.  By range, I mean the difference between the daily high and low.  The range on this chart is expressed as a percentage of price, so a 30-point range when the S&P was at 1500 would be equivalent to an 18-point range now.  We can see that the major low points since the bear market started have equated to 10-day ranges in the S&P that were between 3% - 4% of price, including just a few weeks ago at the October low.  Since the rally off that low point, the range has been getting narrower, and is close to the level it reached near the August 22nd high.  However, there's quite a ways to go before we reach the levels that have closely coincided with other prior peaks in the past two years, which is closer to a 1% 10-day range. 

What shouldn't be a surprise is that the NYSE TICKS closely follow the daily range in the index itself.  The chart below shows the 10-day average range in the TICKS, with one-year 1.5 standard deviation bands surrounding it:

We can see that here, too, when volatility increases enough to push the TICK range out of its upper deviation band, it has usually meant that we were at or near at least a short-term bottom.  Conversely, when volatility lessened enough to approach the lower band, a high price was often soon printed.  This relationship is not quite as clean as the one above, but is still worth noting.  Currently, we are closer to the lower band than we have been in 7 months, although the absolute range is still quite high.  This isn't particularly troubling to me yet.

One of the most reliable overbought/oversold indicators is the following one-year stochastic of the 10-day advance/decline line:

We can see here that at 84%, the 10-day a/d line is becoming quite overbought, though it is not quite comparable to recent past highs.  Past short- to intermediate-term highs during this bear market have consistently recorded readings over 90%, and usually closer to 100%.  However, all it would take is one more day of an a/d reading over 1000 to hit 90% in this one-year stochastic, and a reading of 1500 to hit 95%.

Bullishness increased in the latest Investor's Intelligence survey, which is not a surprise considering what we saw on Monday with the lowrisk.com survey.  The chart below (which is posted to the site each week) shows the bullish ratio (bulls / (bulls + bears)) of the II survey, along with bands that are 1.5 standard deviations from the two-year mean:

We have not seen this level of relative bullishness since May, which although not extreme, is still a bit of a bother.

We now have the three major news reports everyone was anticipating out of the way, and by the time the regular session is open tomorrow, all the economic releases that may have a market impact will also be known.  As I write this, the S&P and Nasdaq futures are 5 and 10 points lower than the regular-session close, respectively.  Apparently the Cisco outlook is not being greeted very warmly.  I try to keep pure technical analysis off of this site, but I continue to believe that as long as we remain above S&P 900 and NDX 1000, the bulls will have control of the action.  We also have a gap in the NDX from Monday's open, and as is outlined in the October 17th daily commentary, upside gaps of 2% or more in the NDX have a probability of being filled within 5 days of 64%, so that 1000 level is likely to be probed soon.  Since we have not quite seen the overbought conditions that we "should" for an intermediate-term high, I am positive on the market until we either reach an overbought condition in more of our indicators or we break through the levels mentioned above.

Tuesday, November 5, 2002  6:27 PM EST

Obviously, with the markets basically flatlined all day, there was not much movement in our sentiment indicators.  Today had the narrowest range in the past month and half in both the S&P and Nasdaq, which should set up a good move in either direction.  Many traders take an entry on a break of the high or low of such a narrow-range day, so that's something to watch tomorrow.

I talked this weekend about a "depressed" VIX, and how we were reaching an extreme in terms of time, but not necessarily price.  That stretch continues today, as the VIX has now been at least 5% under its 10-day moving average for 8 straight days.  There have been four other days of this type of extended downward pressure on the VIX during this bear market.

We can plainly see that each occurrence either marked a short-term high, or was within a day of such.  With only three distinct occurrences, the sample size is much too small to determine a statistically valid conclusion, but what we do see is not encouraging.

Adding to the evidence that we are seeing increasing complacency are the Rydex asset flows, which continue to become more bearish (to us) by the day.  I mentioned this weekend that although the intermediate-term indicators derived from this data were very bearish, there was some room to go in the shorter-term indicators.  That room is about gone, and one more day of flows like we have been seeing will create an overbought condition across the board.  When this happens, it has been a good signal to exit longs and consider shorts over the past year and a half.

No matter what sentiment is saying tonight, the major new events over the next two days will decide market direction in the short- and intermediate-term.  The elections and Fed decision will remove much of the uncertainty and debate currently in the market, so we will have to re-evaluate after the events have passed.  If we were at a sentiment extreme now, we would have more of an edge to game the reaction to the news, but we are not, so I don't see much of an edge at this point.  Contrary to the above indicators, there is room in most of our other intermediate-term indicators for a further rally before they become unsustainably overbought, so if there is a positive reaction to the news tomorrow, then it may be safe to ride the upside for a while.

Monday, November 4, 2002  7:28 PM EST

In the STEM.MR model change and intraday comment today, I mentioned the fact that short-term sentiment was becoming stretched to a degree that is normally associated with future near-term weakness, not strength.  When we get to a point like that, it doesn't take much of a catalyst to push us in the other direction.  It's like a kid riding a bike downhill with no breaks.  It's a fun ride while it lasts, but even a little pebble can send him reeling.  In the intraday comment, I had suggested that it might be worthwhile to try the short side if we saw any more +1000 TICKS in the afternoon, but the closest we got that I see was +700.  Hopefully some of you were able to protect your long profits or even make some on the short side regardless.

The pebble for the market today was a headline that the U.S. may be about to mobilize our reserve troops.  About the time that news crossed the wires, the markets began their afternoon selloff.  The decline into the close was enough to alleviate much of the pressure in our shorter-term indicators.  The NYSE intraday cumulative TICK went from +6200 in the morning to +1633 at the close, and the Nasdaq TICK went from +1600 down to -230 at the close.  Likewise, the S&P price oscillator went from an extremely overbought 70% to 48% at the close and the Nasdaq oscillator went from a peak of 71% to an almost-oversold reading of 41% at the closing bell.

The lowrisk.com sentiment survey was released today and showed a substantial rise in optimism, as the bullish ratio jumped from 42% last week to 51% this week.  The bulls that migrated to the neutral camp last week were apparently emboldened that we didn't collapse, and decided that we would see higher prices after all.  I've been asked why I follow this survey at all, so here's why:

The blue line is the lowrisk.com survey.  The red line is the widely-watched Investor's Intelligence survey.  Since the lowrisk poll is so volatile, I have smoothed it with an 8-week average.  The II survey is shown as a 4-week moving average.  You can see how closely they track each other, and the lowrisk survey typically has about a one- to two-week lead time over the II survey.  Not only that, but the lowrisk survey is typically released on Mondays while the II survey isn't released until mid-week.  This is why I call it our "sneak-peek" - it gives us a heads-up as to what we are likely to see when the major surveys are released later.  What the lowrisk survey is telling us now is that we should continue to see a migration to the bullish camp when the widely-watched polls are released, which may have an impact on those traders who trade based on the II survey (they're more numerous than you may think).  If we see a big jump in bullishness from the II survey, it could prompt some selling on Wednesday.

A little more downside will set up a picture-perfect setup for the bulls, so how the market responds if we get it will be key.  We've already relieved the short-term overbought situation, so there is room here for another thrust upward with the right catalyst (and there are many potential ones in the next two days).  If we hold above the recent highs, like I mentioned this weekend, I would expect more buying to come in and push us higher.  If not, then the bottom of the recent range is a likely target.  Personally, I will be trading light and only short-term until the major uncertainties over the next two days are out of the way.

- Jason Goepfert