Snapshot Notes - October 12, 2006

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THURSDAY, OCTOBER 12, 2006

PostCloseSummary

10/12/06 5:00 PM EST

Coming into today, we knew that it was highly, highly likely that the wedge we had formed over the past week was going to break.

A gap up open is not the best way to begin such a breakout, but when this one held past the first hour, chances improved that the breakout was "real" and by late morning we had a good number of signs that we would see a trend day higher, which confirmed the thoughts from the past few days that it should pay to chase the initial breakout, at least for awhile.

By late afternoon, we began to get some grossly overbought readings in our intraday indicators. I've reiterated time and time again that in the context of a strong uptrend, such a thing is NOT an adequate signal to go short, but it is more than adequate at highlighting a momentum extreme. This means that we should expect further gains to be relatively limited, and mostly temporary - at some point in the next week, we should see prices trade below where they were when our indicators first became so stretched. We have seen this pattern play out several times just in the past couple of months, and I see no reason why it shouldn't repeat.

Also making further gains suspect is the tricky nature of very tight wedges like we'd seen over the past week. Very often (nearly 70% of the time), the initial move out of the wedge is fake. It's possible that yesterday afternoon's plane crash-induced spike down *was* the initial break, and obviously that was a fakeout, but the move was so quick that the cash indices didn't even have time to reflect the breakdown.

Another reason for caution...our Stock / Bond Ratio moved to +2.9 at today's close. That essentially means that the relationship between the two asset classes is very nearly 3 standard deviations away from the average. I went over the precedents for this in a comment on March 15th (click here to read).

OK, here's one more...the S&P 500 proxy, SPY, has now closed above its open for eight consecutive days. According to my data, this has happened only twice before in its decade-long history. Both occurred when the S&P was breaking to new yearly highs, and both were quite poor times to be trying to buy into the rally. After July 8, 1999 and September 4, 2003, the S&P 500 was down more than 3% over the next few weeks both times.

I'm pretty much out of my long positions by now, and am doubtful that further short-term gains from here will be sustained.

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

ApproachingTheBell

10/12/06 3:25 PM EST

The day has unfolded pretty much as it should have after breaking the tight wedge and giving the hallmarks of a trend day this morning.

Now comes the more difficult decision, as our intraday guides have entered nosebleed territory. The STEM.MR model is back to 18%, something that nearly always marks the end of a momentum move. All of the components, except the VIX, are at extremes - most of them grossly so - and that always makes me queasy from a long's perspective.

As I noted on October 5th, though, in a strong uptrend these extremes are not good shorting signals, they are only good at highlighting momentum extremes. Meaning any further upside is usually limited and often temporary. At some point in the following week after such an extreme, prices have a habit of being below where they were when the model hit its extreme. We've seen this exact thing play out several times in the past couple of months.

In addition, I've been noting the tendency for breakouts of tight wedges like we've been in to see a "fake" initial move. All the stop orders get hit, and the momentum chasers pile in - it's good for very short-term traders as we get to participate in what's usually a good momentum move like we're seeing today, but after the initial spike it gets more difficult to maintain the enthusiasm.

I mentioned earlier that trend days like this tend to close at or near their highs, so I'm not expecting a nasty reversal into the close. But I'm starting to really snug up my stops from this morning and will be much more concerned about a partial reversal in the coming days.

LunchtimeLull

10/12/06 12:25 PM EST

The major indices have stayed above the first hour's lows, and in fact we're seeing the earmarks of a trend day.

The definition of a trend day (to me) is when every time the TICK ventures towards or slightly below zero, buying pressure comes in and takes the index to a new intraday high, and every time the TICK reaches an extreme of +1000 or greater, the S&P doesn't retrace any more than 2-3 points. It's rare to get a "perfect" trend day according to those parameters, but it's generally what I look for and it's what we're seeing so far today.

If we go past 11:00am EST or so with this kind of activity, then we usually see it continue and close at or near the highs of the day. That's not set in stone, of course - we've seen some afternoon reversals even after a "trendy" morning, but that's atypical. So I'm still focused on the long side here and will continue to do so until we either hit overbought extremes in our intraday guides, or drop back below the breakout level / first hour lows (around 1354 on the S&P 500 cash index).

MidMorningOutlook

10/12/06 10:25 AM EST

Good Thursday morning...We start the day with a gap up open that has taken us just above the breakout levels so many are watching.

With all the major indices trading at new highs for this move, I'm going to focus on longs for the time being. I don't like when breakouts occur on a gap open - they are inherently unreliable - so I will be using the low of the first hour of trading as an initial "uncle" point.

If we are going to get a true breakout and run a bit today, then we shouldn't trade below those first hour lows, especially since it equates with the breakout level. So I (along with every other short-term trader) will be watching the 1354ish area like a hawk. If we do fail this morning, it opens up the likelihood of at least filling the gap, and possibly making another trip down to the lower end of the range.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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