Thursday, July 10, 2003 10:15 PM EST
For the first time since June 23rd, our intraday cumulative TICK indicator on the NYSE has gone below the zero mark. While historically this is barely oversold, during the uptrend from the March lows such readings resulted in a quick 10-point (at least) rise in the S&P on each occasion as those looking for a dip found their opportunity.
There are a couple of things that are different this time around, however. First, we’ve now seen really the first instance of what might be considered a failed test of a new high in the S&P 500 since the rally began. There was also a potential failure in early April (which also happened to correspond to the weakest bounce from an oversold TICK reading), but at this point the rally is much more mature and the swings have been wider. Also, on July 2nd we saw a tremendous thrust in the indicator to well over +10,000. As I remarked at the time, this was a new three-year record. While those types of readings don’t always mark the exact high (which it didn’t), it does usually signal that we’re seeing an extreme in momentum, and further rallies will likely be accompanied by a successive lessening of that momentum. As that falters, rallies become more and more likely to fail. Think of it as a bicyclist trying to chug up a hill. When she’s fresh and has plenty of energy, high hills are easily overcome. But after the last big hill, which required a huge spurt of adrenaline to surmount, each following hill becomes harder and harder to climb.
Even though the broader market was down well over 1% today, the equity put/call ratio (minus QQQ options) dropped significantly, going from 0.61 yesterday to 0.50 today. This is nearly a full standard deviation below the mean over the past two years. Since 2001, when the S&P 500 dropped more than 1% on the day, this put/call ratio rose 63% of the time. It declined more than 0.05 from the previous day only 28% of the time, so today’s occurrence is relatively unusual. While from a contrarian point of view, this appears to be very bearish, when I went back and looked at past instances, that did not prove to be the case – in fact, this type of occurrence actually lead to a better-than-random performance from the market over the ensuing 1 to 10 days. The last five occurrences (2/7, 2/24, 4/16, 5/8 and 6/13) all lead to a generally rising market, with the S&P being higher every time after 5 days. There isn’t enough here in order to influence a trading decision one way or the other in my opinion, but I wanted to point out that today’s decline in the put/call ratio wasn’t necessarily bearish based on precedent.
On Tuesday, I pointed out the overbought nature of the Down Pressure indicators for the S&P 500 and Nasdaq 100. At the time, I said that if we got another up day on Wednesday, we could see record overbought readings, but we never usually even get to that point since the market has a tendency to decline when such conditions exist. After two days of a down market since then, we’re back to the other extreme, as a down day on Friday would likely push both indicators into oversold territory. These oversold readings have highlighted very good short-term buying opportunities over the past year, with the only true failures being immediately after the trend changes from up to down in August 2002, December 2002 and January 2003. This suggests that if we see weakness over the next day or two (enough to get these Down Pressure indicators firmly oversold), but don’t see a sizable (20+ S&P points) bounce soon afterward, then the chance that the trend has changed to down is heightened.
The cumulative TICK indicator mentioned in the first paragraph above is a component of our shortest-term model, the STEM.MR. In large part because the TICKS have come down so far, this model is now in positive (for the market) territory for the first time since June 23rd, with a reading of 48%. This is a rather mild oversold reading historically, but during the uptrend since March it has been a good indicator that the decline was about over, at least in the short-term. Again, if the market cannot rally soon after seeing such an oversold reading, it increases the likelihood that we are seeing something different than we have during the past three months, and the trend may be changing.
My opinion has been that any rallies towards the mid-June high in the S&P should prove to be good selling opportunities with a time frame of several weeks. While some of our short-term indicators are suggesting that a bounce is near, particularly if we have a down day tomorrow, I have seen nothing that would change my thoughts at this point. I continue to prefer the short side (other than a very short-term trade if we get some more weakness) unless and until the 1015 area is broken and held.
- Jason Goepfert
Disclosure: long OEX puts, long SPX puts
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.
Tuesday, July 8, 2003 11:27 PM EST
Recently, the NYSE released its margin debt figures for the month of May. These margin figures encompass the total amount of debt owed to NYSE member firm by their customers. Most of these customers are borrowing funds, using their stocks as collateral, in order to purchase more stock. Not all investors buy more stock – some take the money out and buy other things, such as cars and houses. This type of leverage can help fuel market gains, but when it becomes extreme it can lead to some serious trouble. Anyone who’s had a margin call during a rapidly declining market will tell you the agony of having to sell their margined stock at depressed prices in order to meet a margin call from their broker. As a former manager of the margin department for a large discount brokerage firm, I can tell you first-hand the emotions involved around margin accounts.
For the month of May, total margin debt increased by nearly 8% over April. This is the largest month-to-month gain in debt since a 9% rise in February 2000. Since that time, margin debt has been decreasing steadily, never rising more than 4% from a previous month (by the way, that 4% rise was in May 2001). This liquidation of margin accounts is part of the reason the market has been under pressure for the past few years. As more and more accounts are liquidated, it places more and more selling pressure on the market. Obviously, not all margin accounts are paid down by selling stock. Some customers simply wire cash to the brokerage firm to pay off their debt. It happens, but it’s relatively rare.
So, we’ve recently seen stock investors take on debt to finance new stock purchases to the greatest extent since close to the top of the bubble, and the market peak in May 2001 before that. While this appears to be a bearish display of investor confidence on the surface, from a longer-term point of view I think this may prove to be the opposite. Margin debt has been on a declining trend for several years now, and if investors can begin to gain more confidence and trade more on margin, that provides a significant amount of fuel for further stock gains, especially considering that rates paid on those borrowed funds are still quite low. Also, consider the chart below. This chart shows a “de-trended” look at margin debt, by comparing the level of debt over the past year to that over the past five years.
On the chart, I have highlighted those times when margin debt was relatively high and began to decline (in red) and those times debt was low and began to recover (in green). While there were some bad false signals in there, each of the four other troughs in margin debt since the late 1960’s corresponded to major lows in the S&P 500. Currently, we are seeing a record low in this indicator. Part of the reason is due to the record high we saw only a few years ago, so that does distort this to a degree. Also, the ratio has not yet began to turn upward, meaning that the trend of margin debt has not yet turned up, forming a support leg for the market. However, like the chart of public vs. specialist shorting I showed several weeks ago, this information appears to further support the idea that we may be seeing more than just another bear market rally. This is not applicable to the market action over the next month or even the next several months, but it does pertain to the next several years and is an encouraging sign.
This weekend, I mentioned that the coming Commitments of Traders report would be eagerly awaited by a large number of traders, after the extreme change seen in the full S&P 500 futures contract the week prior. The report came out without much change, which answers a couple of questions raised from last week – a) was expiration the sole reason there was such a bearish change?, and b) would it quickly reverse? The answers appear to be a) somewhat and b) no.
For the most recent reporting period, small speculator positions were unchanged, as they liquidated an equal number of long and short positions, while commercial traders added approximately 5,000 more long contracts than short. This leaves our indicators which are based on this information, such as the stochastics and Futures Balance Matrix, somewhere between mildly and extremely negative for the market across the board.
In the e-mini contract, small specs have become net short for the first time since early March, while commercials trimmed their net short position by a mild number of contracts. Both of these developments should be positive for the market, but this contract has been so erratic at forecasting market direction so far that I can’t find much value in it.
This weekend, I also mentioned that the high level of the put/call ratio on Thursday was likely more bearish than bullish if anything. Wrong. And that the seasonality surrounding the July 4th holiday historically proved to be strong immediately before the holiday and weak afterwards. Wrong again. Lately, I seem to have whatever the reverse of the Midas touch is – when I mention an indicator or statistic, the market promptly goes the opposite direction it should. In any event, the put/call ratios have reversed themselves somewhat from last week, as the equity p/c ratio closed at 0.48 today, which is the lowest since the short-term market peak in mid-June. The equity ratio minus QQQ options was an even-lower 0.43, also the lowest seen since mid-June. Granted, at that time we saw five consecutive days of low ratios while the market formed a peak, but today’s figures should be watched as abundant call volume in relation to puts is usually never a good sign.
On July 2nd, I said that if we had an up day on the 3rd, we would possibly see record overbought readings from our Down Pressure indicators on the S&P 500 and Nasdaq 100. We never got the chance to see that, as the down market on Thursday relieved the danger of such overbought conditions. However, we once again have a chance to see records if we have another up day tomorrow, at least on the NDX. You’ll recall that these indicators measure the amount of volume flowing into issues which close down on the day compared to those that close positively, as well as the amount of points that are lost as opposed to gained in the underlying stocks for each index. The indicators as posted to the site are three-day moving averages of these readings, and have been relatively effective at pinpointing short-term swings in the market. In order for these indicators to enter truly extreme overbought territory tomorrow, we would likely have to see the S&P rise at least 10-15 points and the NDX rise about 20. Usually, by the time these indicators get to this point, we never actually see the market rise so much the next day, as the market is already short-term overbought. This goes along with most of our other breadth measurements, which are approaching overbought after becoming mildly oversold early last week.
Our Composite model, which rose to as high as 59% on a daily basis on June 25th (the model as posted to the site is a 5-day average), has dropped back down to show the lowest daily reading in nearly two months. At 33%, today’s reading is the lowest since mid-May, and ties the reading seen at the peak on June 17th. This model takes a comprehensive view of many of the breadth and sentiment indicators posted to the site, and will drop as sentiment becomes overly bullish. This correlates well with the “score” given to our intermediate-term indicators, which continues to flirt around the levels seen only at intermediate-term peaks over the past four years.
It’s possible we could see a November 2002 type scenario where price breaks above the previous high, takes out all the buy-stops set just above those levels, then proceeds to form an intermediate-term peak. With some of the bullish arguments I’ve written about several times (e.g. persistent public shorting and lack of specialist shorting, the tremendous breadth thrust we saw during this rally, and now the emerging trend of rising margin debt), I’m not willing to short a new high until we either fall back below the old high or reach a confluence of truly euphoric sentiment readings. However, unless and until we break those highs, as I’ve been saying over the past week, I will be viewing any rallies towards them as a possible shorting opportunity. Unless we break and hold above 1015, my focus remains with finding short trades with a time frame of several weeks.
- Jason Goepfert
Disclosure: long OEX puts, long SPX puts
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.
© 2003 Sundial Capital Research, Inc. All Rights Reserved.