Almost Ready for a Bounce

I’ve spent a good deal of time going over today’s price action, to see if there was some consistent pattern in what it may portend. On the surface, today’s down-up-down action certainly seems bearish, as we weren’t able to sustain the nice gains off today’s open. I checked the price history for the Nasdaq 100 going back to 1985 to look for similar days. I looked for days that rallied at least 2% from the open to the high, then declined at least 2% from the high to the close, that closed within 0.5% of the low, and also closed within 0.5% of the open. Those parameters come up with days like today, but unfortunately it also winnows the universe of days down to only a handful, making it difficult (if not impossible) to draw conclusions from whatever follows. But, I know that many of you are interested in other days like this, so following are the results. From 1985 through yesterday, there were 11 other days that met the criteria from above. The table below shows what happened the given number of days later:

	1 Day Later	3 Days Later	5 Days Later	10 Days Later
Avg Ret	0.8%	-0.4%	0.9%	-1.0%
% Positive	64%	36%	55%	46%
Max	5.7%	7.6%	13.7%	12.8%
Min	-3.6%	-9.0%	-10.2%	-15.4%

Overall, it’s hard to decipher either a positive or negative bias from this data. If we restrict it even further and look at days only since the bear market began, it didn’t change things at all. A couple of the days (5/15/01 and 10/16/02) lead to very nice short-term gains. Some others, like 6/18/02, lead to waterfall-type declines. From the table, one might be able to say that a majority of the time, the market bounced back the next day (up 64% of the time with a good average return), but within 3 days had given up those gains and then some, as the NDX was down within 3 days 64% of the time. Again, however, with only 11 instances to study, it becomes difficult to make too many conclusions. I could have pushed some of the parameters out to gather more occurrences, but then I think we would be getting too far from the original premise.

Bottom Line: With today’s reversal, these wrong-way traders are beginning to bet heavily on further downside.

We’re now beginning to see a little more “give-up” from Rydex mutual fund timers. I mentioned earlier this week that these traders were maintaining – even adding to – bullish positions in the face of a weak market, which was something we hadn’t seen recently and it was not a good sign. With today’s intraday reversal, it seemed to scare some of these traders out of their longs and into some shorts. A couple of our shorter-term Rydex indicators, such as the RSI Spread and the Beta Chase Index, are scraping along near their lows. This shows that traders have been abandoning the high-beta speculative long funds that Rydex offers, and are streaming into the safer or contra-market funds.

I wanted to compare this latest decline to the others we’ve seen so far since the rally began, to see what kind of velocity these traders are moving their money out of the most speculative leveraged funds. It turns out that they’re pulling out now at quite a faster pace than they were before. The table below shows how the assets flowed for each of the short-term declines we’ve seen since the rally began in March.

DATE	DAYS	LOSS	$ MOVE	$ PER DAY	$ PER POINT
03/31	7	6.1	148	21	24
06/30	10	4.2	177	18	42
08/05	21	5.5	349	17	63
09/30	9	5.5	405	45	73
10/24	7	3.0	199	28	67
AVG	11	5.0	255	26	54

11/20	6	4.0	313	52	79

DAYS: The number of days in the decline from the highest close to the lowest.

LOSS: The average percentage loss in the S&P 500 and Nasdaq 100 from the high of the move to the low (closes only).

$ MOVE: The total amount of money that flowed OUT of the leveraged bull funds and INTO the leveraged bear funds. In millions of dollars.

$ PER DAY: The average amount of money pulled out of the bull funds and into the bear funds per day of decline. In millions of dollars.

$ PER POINT: The average amount of money pulled out of the bull funds and into the bear funds per percentage point of decline. In millions of dollars.

The table above shows us that since the top of the latest move, Rydex traders have pulled a total of $313 million out of the leveraged bull funds and/or put it into the leveraged bear funds. Considering the short time the market has been declining, and the relatively modest loss (at least in the S&P), I thought that seemed like quite a bit of money.

Next I looked at how much money that was per day of decline, and also per percentage point of decline. As the table shows, for this latest drop, the traders have pulled out an average of $52 million per day, and $79 million per percentage point of decline (the percentage points are averaged between the S&P 500 and NDX, since I used both sets of Rydex funds). These are the highest we have seen compared to any other decline in the past eight months, and well above the average seen on previous declines. Most surprising to me was the “$ Per Point” column, which shows that these traders are pulling money out at a pace more pronounced compared to the size of the decline than at any other time since the rally began – even late September when I mentioned how absolutely pervasive the negativity was. This type of psychology shift should be positive in the short-term, as these traders have begun to bet quite aggressively on further downside. While our longer-term measures have quite a ways to go before they could be considered positive for the market, at this pace it wouldn’t take long before they too would be signaling that the pessimism was getting overdone.

We’re starting to get a few signs that there may be a little too much negativity creeping in, such as the movements in the Rydex funds as mentioned above. But other measures, such as the put/call ratios (equity options only minus QQQ options) are staying steady or even declining. That is a sign of “ho-hum” complacency that is not encouraging. It is expiration week, so that is undoubtedly having some impact on the put/call figures, but with the price action we’ve seen this week, normally the put/call ratios would be HIGHER than normal, not lower. My work has shown that when expiration week has a negative bias, put/call ratios tend to trend about 7% above where they would be if it wasn’t an expiration week, so the fact that we aren’t seeing higher readings with this decline is a bit more troubling than normal.

We have registered a few oversold readings on some of our breadth measurements, like the Down Pressure indicators I mentioned earlier this week, plus the 10-day average of the Up Volume Ratio, and the daily cumulative TICKS. None of the latter are particularly extreme, but if the uptrend is still intact, then it would be unusual for us to even see extremes - a lesser overbought reading is oftentimes all that’s necessary to allow the uptrend to resume with force. So far with this latest decline, however, the market has not been able to respond very well to even extreme oversold readings. A flaccid one-day bounce is not exactly inspiring.

If we continue to decline for a few more days, break some support levels, and finally get a little more fear going, then it may set us up very nicely for a high-odds short-term rally into one of the most seasonally positive times of the year. But if we simply rise from here, with the same kind of lame action we’ve seen, as I said before, then I would be more willing to short that type of action than buy it. I still don’t see much that has me itching to be long for an intermediate-term trade.

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.