Look Long at 1040 on the S&P

Bottom Line: The past 25 years have shown a mild positive bias to Veteran’s Day, but it doesn’t extend beyond that.

Tomorrow is Veteran’s Day in the U.S. - a legal holiday honoring our brave soldiers that is not recognized by the stock exchanges for some odd reason, although the bond market will be closed. Typically, we don’t see large traders take too aggressive a position when bond trading is closed, so volume should be quite light. Over the past five years, volume on Veteran’s Day has run an average of 11% below its three-month average, so if that holds this year we should see somewhere between 1.2 Billion and 1.4 Billion shares traded on the NYSE tomorrow, all else being equal.

I checked for any bias around this holiday, but there doesn’t seem to be too great of one. Looking at how the S&P 500 performed from 1978 (when November 11^th was re-instituted as the official holiday) until present, November 11^th showed an average return of 0.3%, with a healthy 75% of the days being positive. It should be noted, however, that last year the S&P declined a little over 2% on that day. Going out a little further just for fun, the 12^th was up 59% of the time, the 13^th was up 39% of the time, and the 14^th was up 71% of the time.

Going back to the 11^th, I also checked those times when the 10^th was up or down. That data point didn’t seem to have much of an effect, as the 11^th was up 67% of the time when the 10^th closed negatively, and it was up 71% of the time when the 10^th closed positively. I ignored those times when the 10^th fell on a weekend, so that we were only looking at those times when the 11^th occurred during the week as it is this year.

I’ve mentioned before that I like to think of seasonality factors as being a gentle wind for or against you. Tomorrow, it will be blowing gently at the back of the bulls, and in what is likely going to be a relatively illiquid session, I would think twice about pressing the short side.

Bottom Line: Our shortest-term model is now oversold, a sign that has had very positive connotations over the past seven months.

Since the rally began in March, it has been very rare to see the broader market fail to resume the rally after short-term oversold conditions are reached. That is the reason this is a sign I am looking at to judge the health of the larger trend. If we cannot rally from short-term oversold readings, it suggests that there is not enough “oomph” left to carry us higher. So far, the market had passed these tests almost without question, but we are now presented with another one.

As of today’s close, our shortest-term model, STEM.MR, is at 51% - the highest reading in a month and a half. I counted 11 other instances over the past seven months where the model poked above its upper trading band to see how the S&P 500 reacted afterwards. The table below shows the results for various snapshots in the future after the STEM.MR formed a peak above its upper trading band. In other words, the results are measured from the time the model peaked until the given number of days later.

	½ Day Later	1 Day Later	2 Days Later	3 Days Later
Avg Ret	0.7%	0.7%	1.0%	1.3%
% Pos	91%	82%	64%	91%
Max	1.4%	2.1%	2.8%	2.7%
Min	0.0%	(0.5%)	(0.8%)	(0.9%)

We can see that around 6 hours after the model peaked at a high level, showing that the excessive optimism that had been seen was beginning to wane, the S&P put in quite a good performance. Across all time frames, the average return was positive, the market was higher a majority of the time, and the maximum gain was significantly larger than the maximum loss.

It’s usually easier to see this in graphical form, so the chart below is a scrunched-up version of the model as it’s posted to the site. We’re just looking at oversold readings here, so I moved the scale up so that only oversold readings would show on the chart. The spikes higher in the blue line are the times when the model reached a reading over 40%, and the green line is the upper trading band as it is shown on the site.

We’re about to see how (or if) the market is able to rally off short-term oversold conditions. If it remains true to form, we should see limited downside over the next couple of days, with a high probability of decent gains. If we don’t see this type of action, it will be another warning sign that the larger trend is running out of steam and longer-term investors should become more cautious with long positions.

Bottom Line: Public shorting is at a level more closely associated with stock market lows than highs

As the broader market, defined as the S&P 500, went basically nowhere from mid-September through October, a notable event occurred – public shorting of NYSE issues expanded dramatically, betting that higher prices would not be in the offing. I’ve mentioned before that the “public” as far as these figures are concerned is anything other than NYSE members. So, the shorting numbers include that of hedge funds, and a popular strategy among hedge funds is convertible arbitrage, whereby they buy convertible bonds and short the underlying common stock. With the increased convertible bond issuance we’ve seen this year, there has undoubtedly been an impact on these short-sale figures as well. Because of this, I am unsure how much weight we can give readings such as this, but I believe it’s still important to at least make note.

The chart below shows a 4-week moving average of public short sales as a percentage of total short sales.

We can see from the chart that during this latest consolidation phase, public shorting as a percentage of the total has risen dramatically. The four-week moving average went from 46% as of September 5^th all the way up to 51% as of the most recent data available, which is the week ended October 24^th. During that time the S&P 500 gained a grand total of 0.7%. This data is now the highest it has been since the Spring rally began, and as you can see it has done a decent job at highlighting some of the market turning points when it reached an extreme.

If the data can be trusted to be reflective of a public that is betting against higher prices, while the market is rising, then it bodes well for an extension of the Spring rally over the coming weeks and/or months. Combined with some of the other longer-term studies I’ve shown recently, such as the historical overbought readings and the price persistency of the S&P 500, there are certainly more than a few longer-term bullish signs out there.

Bottom Line: Today’s reading was exceptionally high considering the market activity, and if the pattern holds then it is a very bullish sign over the coming week.

For such a mild down day, there was heavy put volume in relation to calls. My preferred measure of this data, available on the site daily, is the CBOE equity-only put/call ratio with QQQ options removed. The ratio reached 0.77 today, which is the highest since May 22^nd, and is the second-highest seen since this rally began in March. Looking at all readings of 0.74 or higher, there were 8 occurrences since the rally began. The average maximum drawdown over the next five days was a miniscule 0.7%. The average maximum gain over the next week was a hefty 3.0%.

Below is a chart of this put/call ratio, with arrows highlighting the highest ratios.

Obviously, if the pattern that we’ve seen over the previous seven months holds, then the downside risk over the coming week or so is dwarfed by the potential reward, as traders realize the action over the past couple of days is normal corrective behavior.

Last Thursday, I noted that I had no desire to chase any upside generated by a positive employment report on Friday, but I did have an interest in shorting it. But now shorts are running into the same problem they’ve seen almost since the rally began – there are so many traders switching sides so quickly that the downside tends to be muted. In the very short-term, as noted above, the signs are positive enough that I would be more interested in the long side, particularly if we see enough weakness first to take us down to the 1040ish area on the S&P 500 cash index. If, however, the broader market cannot rally in the face of these positives, then the longer-term sustainability gets called into question.

This disclosure is not intended as trading advice in any form. It is meant as a note to subscribers that the author may have a position directly affected by the market outlook reflected in the commentary. Although the author takes great pains to remain objective in any commentaries, it is only fair that readers should know that the author may have taken positions in accordance with his market outlook. Positions can and do change at any time, without notice to the reader.