Snapshot Notes - September 27, 2006

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WEDNESDAY, SEPTEMBER 27, 2006

PostCloseSummary

09/27/06 5:00 PM EST

The "Approaching The Bell" comment from earlier summed up my thoughts pretty well, and the last half-hour of trading didn't change anything materially, so instead of repeating myself, I'm going to leave those as the post-close comment...

ApproachingTheBell

09/27/06 3:25 PM EST

With a constant stream of sickening cheerleading on CNBC, a big SPX / NDX divergence, a STEM.MR model reading in nosebleed territory and an intraday reversal today, the pieces look to be in place for a pullback.

I've been hesitant to bet on that probability because of what has felt like unnatural market movements the past couple of days, and I'm still not interested in aggressively pressing the short side here. I do think we'll get a good whack to the downside, beginning anytime in the next week or so, but I'm concerned with the timing because of the action over the past two days.

I'm not really interested in doing anything on the long side in the major indices, but want to see more evidence of buyers stepping away before committing too much to the short side. A move back under the high at 1327 in the S&P would be a good step in that regard. With the exhaustive short-term model reading we got this morning, the probability of further sustained upside seems unlikely, so I'm kind of in a holding pattern here and waiting for sellers to finally step up the pressure before I join them. As I mentioned yesterday, I'm playing things very close to the vest and am being more conservative than usual.

LunchtimeLull

09/27/06 12:25 PM EST

Today has been a nearly exact replica of yesterday, with some early-morning volatility followed by a move higher that feels very forced once again - maybe it's all the employees of the financial TV channels who have pooled their money to get the Dow to at least tick at a new all-time high.

Our STEM.MR model is now at 18%, one of the most-stretched readings in months. The only two recent occurrences that approached this kind of extreme were August 17th and September 12th, both of which coincided with a temporary exhaustion of the rally.

I've been noting that the intraday trading behavior feels unnatural, so I'm being even more conservative in my outlook than usual since I'm not sure how much we can rely on formerly reliable measures for the time being. Given that, I don't think any further pushes higher are going to last, and gains made from here I expect to be given back quickly once the buying pressure - where ever it happens to be coming from - backs off. Whether that's today or next week, I don't know, but the risk is high and getting higher for short-term longs.

MidMorningOutlook

09/27/06 10:25 AM EST

Good Wednesday morning...Last night, I posted a new Chart in Focus Video that goes over the current divergence we're seeing between the S&P 500 and Nasdaq 100. The former closed at a new 52-week high yesterday, while the latter was still more than 5% below its own high.

We saw a similar thing in March of this year, but not quite to this extent. We'd have to go back to early March 2005 for a comparable situation, and I wrote about it at the time (click here to read comment).

You can read the comment or view the video to get a more detailed view of what happened afterwards, but in summary there have been 8 prior instances of this happening. One month later, the NDX was negative all 8 times, and by an average of -3.4%. The average maximum gain during the month was +1.8% compared to an average maximum drawdown of -5.5%. On average, it took 4 trading days for the market to top out after seeing one of these divergences.

We're about to head into the most historically volatile month of the year in October. While the big seasonality themes have not played out very well this year, it's at least worth noting that October has the widest variation of any other month between average (and maximum) gains and average (and maximum) losses - meaning we've seen a bunch of wild swings on a consistent basis.

While on average the end of the month has been higher than the beginning, the NDX has dropped an average of 7.8% during the month and the S&P 3.8%. During 16 of the last 20 years, the NDX has declined at least 3% from September's close sometime during the month of October.

On a side note, over the past 20 years if September was positive going into the final three days of the month, then those final three were positive 5 out of 7 times, but the average return was just above zero.

As for the short-term, we're seeing morning strength once again. Whether it's fund positioning or whatever, this is hard to fight and I'm not doing so. I outlined yesterday the things that would have me interested in shorting, and while we're not quite seeing any of those yet, our STEM.MR model this morning has approached its overbought trading band, something that has coincided with trouble in equities going forward, so I'm becoming more aware of the potential for the breakout to begin to fail.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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