Snapshot Notes - October 5, 2006

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THURSDAY, OCTOBER 5, 2006

PostCloseSummary

10/05/06 5:00 PM EST

A couple of weeks ago, I mentioned that this felt like the kind of market where the only thing that was going to work was to "close your eyes, plug your nose, and buy". That's not my cup of tea whatsoever, but it turns out that it would have been the best piece of advice.

The recent momentum has been exceptional - our STEM.MR model this morning hit its most extreme reading since I began keeping it in its current form, which dates to the beginning of 2004. The next most-extreme reading occurred on November 4, 2004, which was under somewhat similar circumstances, and ended up leading to another couple months of a creeping uptrend. Typically, though, when we get these kinds of model readings in the midst of a strong uptrend, it marks a short-term exhaustion point where any further gains are given up within the next few days.

Earlier today I went over a few stats regarding historical market performance during the meat of October, and when September showed a midly positive return, then mid-October was negative every time in the eight years it occurred.

So there seems to be good reason to expect gains like today to moderate and be given back in the next week or two. The problem is there have been plenty of good reasons over the past month to expect short-term pullbacks, and other than a day or two, they haven't amounted to much.

I still have zero desire to try to short this thing - there just isn't enough compelling evidence for that yet - but I want to see something with a better risk/reward before buying for anything other than a scalp trade like yesterday afternoon. Perhaps there are too many people in the same position as me so it's less likely to happen, but buying breakouts and chasing momentum in equity averages is overwhelmingly a losing strategy. I'm still looking to buy the first retracement back towards the breakout levels of 1340 in the S&P and 1665 in the NDX.

Have a good evening and we'll see you tomorrow!

ApproachingTheBell

10/05/06 3:25 PM EST

The relentless march higher continues as the major indices tack on yet more gains. Our short-term guides have begun to cycle back towards neutral, which is normal after a momentum peak like we saw yesterday.

The STEM.MR model earlier today reached its most extreme reading since I've been keeping in its its current form (January 2004). Such extremes tend to mark momentum highs in equities as well, with any further short-term gains having a tendency to reverse sometime in the next week or so, but as I noted previously, in strong uptrends like this severe overbought readings are not good shorting signals, only a sign that the momentum is likely to wane.

When we combine that with the "meat of October" stats, it seems unlikely that rallies like today will be sustained, but even so I still don't think trying to short is a good idea. I also don't think buying is a particularly good short-term idea, which has obviously been way too conservative given what the market's done lately.

LunchtimeLull

10/05/06 12:25 PM EST

The major indices have been stuck in an extremely tight range so far today, with the S&P not moving more than a few points from high to low.

There's still a long way to go in the day, so obviously this is premature, but if the difference between the intraday high and low in the S&P 500 today is under 6.5 points or so, we'll have seen one of the tightest intraday ranges after hitting a new high that we've seen over the past few years.

The textbooks tell us that this is bullish - it's supposed to be a good sign of consolidation that serves as a launching pad for another push higher. Well, since 2003 there have been 7 other days that showed an intraday range tighter than 0.5% of the closing price the day after the S&P hit a new 52-week high. A week later, the S&P was positive only 1 of those times, and the average return was -1.0%. Pull up a chart of late December 2004 or early May of this year for examples of what can happen.

Anyway, I noted earlier what would get me interested in buying or selling here, and I'm not seeing either one develop yet.

MidMorningOutlook

10/05/06 10:25 AM EST

Good Thursday morning...We've had a pretty good start to an historically rocky month - so far in October, both the S&P 500 and Nasdaq 100 are up over 1% from September's close.

That's just a bit unusual, so let's check out other years where the first three days of October were up by 1% or more in the S&P and see how the next few weeks fared. Since 1950, it has happened 24 times, and looking out three weeks later (which takes us into the last week of the month), the S&P showed a positive return only 6 times (25%). The average return was -1.2%, the average maximum gain was +2.0% and the average maximum loss -3.2%.

Here's another interesting fact - if we also stipulate that September was positive by 2% or more (as it was this year), then the meat of October showed a positive return 0 out of 8 years with an average return of -2.7%.

Of course, September was supposed to be weak from a seasonality perspective and it wasn't, so those who place more weight on recent occurrences in their indicators may want to take that into consideration.

In the short-term, I noted after yesterday's close that I would be interested in buying the first approach toward the breakout levels of 1340 in the S&P 500 and 1665 in the Nasdaq 100. If we would happen to see a few short-term oversold readings coinciding with that, all the better, but I think the first test will bring in buyers regardless, at least for a short-term pop.

As for shorting, I noted that about the only thing that would interest me from a risk/reward standpoint would have been a big gap up opening this morning, which we did not get.

Our short-term guides are stretched well into overbought territory heading into today, so that brings with it increased risk from the long side, even on a very short-term basis. In strong uptrends like we're seeing, when the STEM.MR model breaches its upper trading band, we very often see a reduction in momentum and at some point over the next few days prices trade back below the price where the model first became extreme, which is another reason I don't think another push from here will be sustained.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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