A Long-Term Look
Tuesday, November 16th, 2004 9:15pm EST
Breakout from Range Should Carry Long-Term
Bottom Line: The breakout in the S&P 500 from an extended trading range has, in the past, lead to positive market performance going forward.
The past few comments have focused on mostly short-term readings from some of our indicators, so tonight I want to step back to try to get some perspective. In May and again in July, I wrote about how the Dow Jones Industrial Average tended to perform after extended periods of being more than 5% above its 200-day moving average and after long periods in a trading range. The first piece told us that it would have been exceedingly unusual to see the DJIA just roll over into a new bear market after the type of performance we saw in 2003. The second told us that while it had been a long time since we saw a new 52-high or low in the index, we would most likely see several more months of a trading range before it broke out.
While the Dow has not yet made a new high on the year, the S&P 500 has, so I thought it would be relevant to check the same stat for that index – namely, how it tended to perform after breaking out to the upside after an extended period without making a new high or low. Looking at S&P data from 1950 through the present, there have been 17 streaks where the index had gone at least 100 consecutive days without making a new yearly high or low. The most recent streak, which ended on November 4th when the S&P closed above 1161, lasted 184 consecutive days, which was just a bit longer than the average streak of 167 days.
Historically, what we see is that 5 days after one of these streaks ended due to the index closing at a new yearly high, it was positive 16 out of 17 times, with an average gain of 1.3%. It has already been five days since the latest streak ended, but I think it’s important to note that it, too, was positive, and gave us a return right in line with the average. This tells us that so far the market is performing in sync with its historical pattern after breaking out of an extended range.
What might it mean longer-term? 30 days later, the S&P was still positive 13 of the 17 times, with an average return of 1.7%. After 90 days, it was higher 14 times with an average gain of just over 4%, and after one year it was higher 16 of the 17 times and the average return came in at 11.4%.
Instead of absolute returns, if we look at the future performance in terms of risk versus reward, we see that the average drawdown (the most prices went against you) over the next 30 days was 1.6%, while the average maximum gain was more than twice that, at 3.4%. Even looking out one year later, the average drawdown was a relatively tame 5.3% while the average maximum gain was nearly triple that, at 15.1%. That’s not to say there weren’t some scary moments, times when it wouldn’t have paid off to be a buyer after such breakouts. After occurrences in 1961 and 1990, one would have languished with a losing trade for more than six months before eventually showing a gain, and would have encountered a drawdown in excess of 10% at some point during that time. But overall, the implications are bullish for the longer-term.
This Ain’t 2000
Bottom Line: Any comparisons of recent market action to 2000 falls flat when viewing the health of customer margin accounts at NYSE and NASD firms. Currently, there is more cash available to be invested in these accounts than any time since the bottoming process in 2002.
One of the figures that we update on the site each month is the margin debt and free cash balances from New York Stock Exchange (NYSE) and National Association of Securities Dealers (NASD) supervised clearing firms. These firms house billions of dollars of investors’ securities and money and they report regularly on the balances in these accounts. I feel that the best way to view the data is via “available cash” which is simply the assets in the accounts (free credits in cash and margin accounts) minus the liabilities (margin debt).
The most recently released figures from the NASD, which covers data through September, shows that this available cash figure was once again near an all-time record high. Margin debt decreased substantially from its peak last July, while free credit balances did not back off nearly as much. This has left these accounts in a very strong position, as they would be able to pay off all margin debt and still have billions of dollars left to use as they see fit (such as buying equities).
While the figures for the NYSE are off their highs, there is still a positive balance to the tune of over $14 Billion. Combined with the $13 Billion from NASD firms, the total cash available to investors is substantial and is outpaced only by the period from July 2002 through March 2003. And it is a world apart from the combined negative $130 Billion seen in February and March 2000.
In discussing this indicator previously, I have stressed what I believe is an important point – this available cash figure, prior to the current instance, had not been positive since 1950. Seeing such a balance available to investors is heartening indeed, as not only is it a potential source of funds to be put to work buying stock, it also suggests that there may be additional money on the sidelines that could come into play. As long as the figures are this positive, the chances of a lengthy, pronounced bear market are slim.
Bullish Commitments
Bottom Line: The Commitments of Traders data for the S&P 500 futures shows the most bullish configuration since March 2003.
Something else I haven’t talked about for quite awhile is the positioning of large professional (commercial) traders and small speculators in the S&P 500 futures contracts. I have written at length about the problems I have had in interpreting this data since the e-mini contract took on prominence about a year and a half ago, but recently the pattern in the contracts is similar to another period in time – the Spring of 2003.
The chart below shows commercial positions (in green) and small speculator positions (in red) for both the full-sized S&P 500 futures contract and the e-mini contract.
The highlights on the chart show something striking – recently, commercial traders in the full contract became more net long than small speculators. This is the first time this has occurred since the spring of 2003, and a rarity since 1999. At the same time, commercials have become quite net short the e-mini contract, just as they were in the spring of 2003.
The similarities in the positions between now and the kickoff of this bull market cannot (and probably should not) be ignored. While I certainly have my misgivings about giving this data too much weight, I find the recent pattern to be too strong to ignore. Despite its possible shortcomings, I believe this data has bullish intermediate-term implications.
Conclusion
I could go on and on about some of our severely overbought sentiment gauges. Rydex traders continue to trade the most speculative of issues; equity put/call ratios yesterday were the lowest since January; OEX call open interest has declined the most in five years as these smart traders continue to move away from bullish market exposure; our Odd Lot Purchase Percentage is now at a new 34-year high as small traders try to jump on board the breakout in the broader market.
While many of our sentiment measures are flashing strong warning signs, I continue to feel that it is premature to try to short now. The information discussed above, and the splendid price action, make it seem as though any short-side attempts should be very short-term in nature. But if not already long, it’s also difficult to suggest establishing new positions here, as our measures show that there is a significant degree of short-term risk since so many who are normally so wrong are on one side of the ledger. So my position is to continue to wait patiently for a time when risk is lessened on either side. That likely means a pullback before establishing new longs, which unfortunately is what so many others are waiting for too.
Jason Goepfert
President and CEO
Sundial Capital Research, Inc.
Disclosure: no positions
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.
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