Snapshot Notes - October 4, 2006

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WEDNESDAY, OCTOBER 4, 2006

PostCloseSummary

10/04/06 5:00 PM EST

One of the highlights of the move over the past few weeks is that our longer-term sentiment measures have not been showing many consistent extremes - we've got a few "too pessimistic" ones, a few "too optimistic" ones, and a whole lot of "not sure".

On a shorter-term basis, we have seen some good swings over the past few weeks, and for the most part our intraday guides have done a good job at pinpointing likely reversal points. Now, for the first time since September 27th, the STEM.MR model for the S&P is back to an extreme overbought condition, on both an absolute and relative basis. A move out of the upper trading band is an early-warning sign that momentum is likely to slow.

An overly optimistic reading like this, when seen in the context of a strong uptrend like we have, is not reliable as an outright sell signal, and I would not interpret this one as such. However, we very often see a definite moderation of the momentum, with small, choppy gains (if any) going forward. Most often, further gains from this point are given back sometime within the next week, at least temporarily.

I noted early this afternoon that if the S&P futures followed the cash index and broke to a new high, then I would be resigned to scalping trades from the long side. While that can work for awhile, it becomes less effective after we cycle back into a severe short-term overbought condition, which is what we've just entered. So I will be backing off that and instead looking for a better setup - which would involve shorting a large gap up opening, or looking to buy the first approach towards 1340 in the S&P and 1665 in the NDX.

Have a great night and we'll see you tomorrow!

ApproachingTheBell

10/04/06 3:25 PM EST

With the thrust we've seen in the major indexes this afternoon, we finally are getting some extremes in our short-term guides, hinting that the air is getting thin again.

The STEM.MR model for the S&P is now above its upper trading band for the first time since September 27th. While it isn't quite as extreme on an absolute basis as some of the other extremes seen over the past few months, it's getting there in a hurry and if we close strongly, which is likely after a day like today, then it's possible it will "max out" in overbought territory by the close.

In a strong uptrend like we're in, such a thing doesn't necessarily mean that we're about to top out immediately, but it almost always at least signals that the big momentum move is done and the gains will moderate. When it reaches such a level, at some point during the next week prices usually dip below where they were when the model hit an extreme, which is another way of saying that further price gains are most often given back at some point over the following days.

I noted earlier that if the S&P futures broke to a new high and held, that I would be scalping from the long side, and that's what I've been doing all afternoon. Now with our short-term guides cycling into an extreme, even scalping carries higher risk, so I will be backing off that by today's close.

LunchtimeLull

10/04/06 12:25 PM EST

Stocks continue to chug higher, with the Dow at another record and the S&P at fresh yearly highs as well. This may be nothing, but it's interesting to note that the S&P cash index, and the SPY exchange-traded fund, both hit new highs intraday today, but the December e-mini futures contracts have so far fallen just shy. It's not a huge divergence, but in strong moves we usually see all cylinders firing.

I've been mostly on the sidelines, and sometimes that's even more frustrating than being on the wrong side of a trade. Even with today's move, our intraday guides are not giving any kind of "too far, too fast" readings yet, so there's no reason from them to expect an imminent reversal. And obviously with the indices hitting new highs, we're not seeing any kind of confirmation of price weakness, so shorts for me remain out of the question.

The only alternative to sitting in cash or being short is to be long, but as I've been noting I'm not comfortable with the risk/reward there either as I think these gains will ultimately be given back when looking out over the next couple of weeks. However, if the S&P futures get in gear, and trade (and hold) at new highs, I will focus on short-term scalps from the long side as long as those new highs hold. I don't particularly like trading that way, but it's about the only fit considering my outlook and trading style at this point.

MidMorningOutlook

10/04/06 10:25 AM EST

Good Wednesday morning...Yesterday we saw an extremely unusual occurrence - a major index broke to a new all-time high, yet the equity-only put/call ratio on the Chicago Board Options Exchange recorded its highest reading in over a year.

With nearly as many puts traded as calls, that put/call ratio was giving a reading last seen at the low in April 2005. With the Dow at a new all-time high, it would suggest that there is a huge amount of hedging going on with this rally.

Unfortunately, it's a lot less exciting than it seems. Halliburton had a really bad day yesterday, suffering a large decline to a new yearly low on huge volume - not just in the stock, but also in the options. If we back out just that one stock's option volume, then the put/call ratio would have gone from 0.98 to 0.66, which is actually on the lower end of its range.

I'm not a fan of making excuses for indicators, or adjusting them to fit our beliefs. But when one of them gives a highly unusual reading, then it behooves us to investigate. Yesterday's option totals were extraordinary, but it would be a mistake to assume that investors in general are overly pessimistic about this rally's prospects just because option volume in HAL was extremely high.

The Investor's Intelligence sentiment survey released their latest findings today, showing a rise in bullishness to just under 50%, the highest amount since April. That sounds bad (for bulls), but the percentage of bears "bear"ly budged (sorry) and remains close to historically pessimistic levels. Overall, I would consider it a neutral to moderately bullish factor for the market going forward.

As for the short-term, I remain on the sidelines. Our intraday indicators are mixed at this point, but I simply do not trust the sustainability of a breakout to new highs when looking out over the next couple of weeks. But in order to concentrate on shorts, I want to see some confirmation that the market's character is changing. By that, I mean I would need to see the S&P trade (and hold) below its previous yearly high at 1327, or see our short-term indicators become oversold and the market NOT rally from that. As we saw yesterday, oversold conditions are still bringing in buyers, which makes it especially difficult on the short side except for scalp-type trades.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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