Snapshot Notes - December 5, 2006

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TUESDAY, DECEMBER 5, 2006

PostCloseSummary

12/05/06 5:00 PM EST

Despite relatively lackluster trading in many higher-beta sectors including technology and small caps, the broader market tacked on another day of gains today.

I've been focused on the probability of seeing a "false" breakout in the S&P 500, based on the recent solid record of peaks in momentum coinciding with a market that was about to go nowhere to the upside.

Over the past four months, every time the STEM.MR model exceeded its upper trading band, the S&P either went into a short-term dip or entered very choppy conditions. The two times it managed to add more gains over the next day or so, it suffered a relatively stiff whack shortly thereafter.

A rather incredible reading we got today was that according to my quote vendor, 575 stocks on the NYSE closed at a new 52-week high. There are those who would suggest such a thing is a good indication of a healthy market.

I'm not so sure about that, so let's just look at the facts, and find any other day with this many stocks closing at a new high over the past decade. I can find only three other instances - October 3, 1997, June 6, 2003 and three days in December 2003/early January 2004.

After the 1997 instance, the S&P topped out two days later and went into a 9% tailspin over the next few weeks. After the June 2003 instance, the S&P topped out a week later and then went nowhere for two months, suffering about a 5% drawdown along the way. After the December instance, the S&P was able to tack on some good gains over the following month, then lost it all (and more) as equities traded in a downward range for the next eight months. I don't really see any reason to celebrate there.

Something I've been looking for (in vain) over the past couple of weeks is that "this time is different" in terms of the market of the past four months. I haven't found any evidence of that, on either the upside or downside, so I'm going to keep with the idea that the long side is quite risky here given the consistency with which gains were given back previously when our short-term model hit an extreme.

Since the S&P has managed to hold at new highs, though, I'm only willing to try a short if those highs are given back and the index falls back below 141 in SPY (1410 in the e-mini futures).

The longer-term "mechanical" site position has changed back to long at today's close after I held off for a day to see if the S&P was going to hold above its previous high. Personally, I think this is going to be a whipsaw signal, but I don't want to override the guidelines too much as they've done pretty well over the last decade.

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

ApproachingTheBell

12/05/06 3:25 PM EST

I've been pretty adamant about equities having hit a short-term peak in momentum yesterday according to the STEM.MR model.

The reason I keep brining this up is because future performance in the S&P 500 has been consistent after other model extremes during the rally. For example, there have been 12 instances of the model exceeding its upper trading band since August 1st. Of those, 8 lead to at least a 10-point decline (from the point the model became overbought) within a week, mostly of them beginning almost immediately after the model hit an extreme. Each of the other 4 lead to at least a 5-point decline and mostly choppy conditions in the days following.

Only two instances resulted in the S&P continuing higher uninterrupted, at least temporarily. Those were after extremes were reached in the morning of October 13th and again the early afternoon of November 15th. After the October occurrence, the S&P was able to climb for an extra day before seeing a relatively wicked one-day drop, and after the November one it was able to hover mostly unchanged through Thanksgiving before suffering a nasty post-holiday hangover.

So even during the strong uptrend of the past four months, such extremes in the model lead to either a near-immediate decline or very choppy market conditions. The two times equities were able to sustain a further short-term advance, we got a nasty one-day reversal sometime in the next few days.

Perhaps I'm relying too much on something that has been quite consistent, but I continue to think the risk of being long in the short-term is very high. The risk on shorts is also quite high, since prices keep rising, but I will be willing to try a shot on the short side if the S&P drops under the recent highs (roughly 141 using the S&P 500 exchange-traded fund, SPY, or 1410 using the e-mini futures).

LunchtimeLull

12/05/06 12:25 PM EST

We had a high-volume spike off of the economic releases at 10:00 this morning, and the major indices have been consolidating that move ever since, leaving us slightly positive on the day.

If we could see a further downside reversal this afternoon, it would increase the likelihood that we've seen the peak in momentum that I've been writing about since yesterday afternoon, and I would be willing to try the short side if the S&P 500 lost its previous high around 1405ish, but not until then. I'm not interesting in trying to chase the long side based on the market's previous reactions to short-term overbought conditions.

MidMorningOutlook

12/05/06 10:15 AM EST

Good Tuesday morning...In the Post Close Summary yesterday, I showed a chart of the STEM.MR model for the S&P 500, and its movements over the past month.

I could have just as easily shown it for the past three months, since the song is the same - when we saw evidence of short-term peaks in momentum, as defined by the model exceeding its upper trading band, the S&P 500 tended to stall out and any further short-term gains were given back within a week.

While it would have worked out most of the time, these "signals" are not consistently successful times to enter short positions in the context of a strong intermediate-term uptrend like we have now (in a flat or declining market, though, it's a different story...).

Given that, and the fact that the S&P has been able to hold above its previous highs around 1405ish, I'm not considering short positions at this point - though I would if we fell back below that breakout area sometime today. I do think there's a relatively high chance of this breakout failing within the week, but I need some evidence of that first before acting on it.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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