Mar 03, 2003

Similar to last Wednesday, once again today there is a real lack of topics to go over. I've gone over each indicator and model, looking for some possible edge to discuss, or further analysis that may not be evident on the surface. I cannot find even one item. Perhaps this has been a good thing with the environment we've experienced, with really nothing but intraday trends, but it is sure getting old. I know many of you are looking for better direction, but I cannot in good faith suggest we have an edge where no solid one exists (within the world of sentiment), just to have something to say.

We all know by now that volatility tends to be mean-reverting. High volatility often follows low volatility as the market expands and contracts. We are currently in an extremely low-volatility period, as is evident from the volume differential and S&P 500 range as posted to the site. While this is normally a bearish development, more than that it suggests that we are at a point of either extreme complacency or equilibrium. I don't think it's complacency (primarily note the high VIX fear premium), so it is more likely that we have reached equilibrium - buyers and sellers currently see no compelling reason why prices should be at a place other than where they currently are. Think of it as a perfectly balanced teeter-totter. It doesn't take much of a catalyst from one end to start the lever going in the other direction, and that is what will happen to the market soon. A catalyst will come down the pike that tips the scales in one direction or the other. When that happens, and the trading range is broken (S&P 820-830 initially, then 806-855), I suspect the bandwagon will get quite full before the trend reverses. I've spoken to many traders over the past few days, and almost without exception, they have put their usual methodology on hold and are looking to trade in the direction of whichever way we break. Therefore, although this is certainly not my preferred trading style by any means, I would look to trade the direction of the breakout. Not the first violation, but preferably some reaction back towards the breakout level.

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.

Tonight's comment will be fairly brief. For those who have sent emails since the close, I will get to them shortly. I had to rush my youngest son to the hospital late this afternoon and am only now getting back into the swing of things. I tell you, there's no worse feeling in the world than picking up your phone and hearing "Your son has had a bad accident". Boys will be boys I guess, and he should be just fine.

Today's closing NYSE TRIN reading of 3.46 is the highest reading in nearly three years. Some of you may have a different reading based on your quote vendor's breadth figures. In double-checking my data, I saw separate sources showing a TRIN as low as 3.30 and as high as 3.70, so my reading of 3.46 is within the range. Regardless, it is one of the most extreme closing readings we've seen in a decade, and is in the top 0.3% in the past 40 years. As I mentioned in the portfolio change this afternoon, the market has a tendency to rebound shortly after seeing such lopsided selling action. The table below outlines the S&P 500 reaction after NYSE closing TRIN readings over 3.0.

	1 DAY	3 DAYS	5 DAYS
Since 1965...
Avg Return	1.0%	1.5%	2.0%
% Positive	70%	63%	59%
Max	5.3%	10.4%	12.3%
Min	-1.9%	-2.2%	-3.2%
Since 1993...
Avg Return	1.9%	2.5%	3.9%
% Positive	90%	90%	80%
Max	5.1%	5.2%	7.1%
Min	-0.3%	-0.6%	-0.9%

This table excludes the day before the market crash in 1987, which had a closing TRIN of 5.79. I think it's safe to say this instance was an "outlier" and does not represent typical market behavior.

We can see that in the past decade, such high TRIN readings have been extremely positive for the market. The average return is very positive over every time frame, with at least an 80% success rate (there were 10 occurrences). Most impressively, however, the largest failure over each time frame was under 1%, while the maximum and average returns were significantly larger. In addition to the daily reading, the 10-day average has pushed up to 1.48 as of today's close. While not what I would consider extreme in this market environment, it is getting close. If we get another down day tomorrow, with a closing TRIN reading upwards of 2.50, then the 10-day average will climb to 1.60. When the average has reached this level or higher, we almost invariably see a short-term oversold rally in the following days. From a trading aspect, these precedents present us with a compelling reason to look on the long side beginning tomorrow.

As a possible precursor of things to come in the sentiment surveys, the latest lowrisk.com survey came out with one of the lowest bull ratios in its 6-year history. The percentage of the population who expects the Dow Jones to decline at least 2% over the next 30 days was 66%, the fifth-highest reading in its history. I like to watch this survey's movements since it tends to track the widely anticipated Investor's Intelligence survey. If you plot an 8-week moving average of the lowrisk survey versus a 4-week average of II, their peaks and troughs correlate fairly closely. Currently, the moving averages of the two surveys (8-week for lowrisk and 4-week for II) are not at a point that has been seen at past intermediate-term lows. It would likely take another week at the very least to see these averages drop to recent historical lows.

This weekend, I pointed out that the Down Pressure indicator would have likely given a sell signal should we have gotten an up day on Monday, as there was a real lack of selling pressure late last week. Since this indicator is based on a three-day moving average, we're facing the opposite situation now. If we get a moderate down day tomorrow, say with a daily Down Pressure reading of 80%, then the indicator (which is a three-day moving average of the daily readings) will reach extreme oversold territory at 85%. When this indicator spikes to this type of extreme level, it has been a good precursor that the pace of selling is unsustainable and is likely to take a breather. Again, however, this is short-term trading stuff only, and not an indication that an intermediate-term low is necessarily at hand.

With some of our shortest-term measures now flirting with oversold territory, the STEM.MR model approaching its upper trading band, and the TRIN outlook as described above, the risk/reward is shifting to the long side in the short-term. If we get a large gap down open tomorrow (say greater than 5 S&P points), then I would look to be a buyer of that at the first sign of a reversal. This is with the knowledge that it is a contra-trend trade and it should be treated accordingly (i.e. smaller position size and tighter stop loss). If we don't get a solid reversal and instead have another large selling day tomorrow, then I would likely look to become considerably more aggressive on the long side near the close Wednesday or preferably Thursday morning. This would be for a short-term trade only, possibly even intraday, but I think the opportunity for a high-odds, low-risk trade will be there. Longer-term, I continue to believe that we have not seen the type of emotion or volatility that we need to see in order to be more confident that the reward of higher prices justifies the risk of lower ones. Therefore, if we do get some type of rally over the coming days (of course, barring a major geopolitical development), then it would probably set up another shorting opportunity.