Snapshot Notes - December 7, 2006

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THURSDAY, DECEMBER 7, 2006

PostCloseSummary

12/07/06 5:00 PM EST

After gapping up at today's open, most sectors and by extension the major indices saw selling pressure increase as the day wore on.

For the first time in a long time, this afternoon I began hearing rumblings from more than a few traders about "something" out there, possibly irritated by questions about Ecuadorian debt. With the thousands of junior hedge fund managers who have stretched for any kind of yield premium, problems in one market can easily domino into others.

I've heard these kinds of warnings before, and so far it's had no market-wide impact. All I know right now is that the S&P 500 has dropped back to touch its breakout level (and the Nasdaq 100 its multi-month uptrend line), and our short-term models have become oversold in the process.

Previous instances of the models becoming oversold during the past four months have lead to imminent lows in equities, though there is some reason to expect additional short-term follow-through to the downside. Over the past decade, there have been 13 other instances where the S&P gapped up on the open, traded to a new 52-week high, then reversed to close below the prior day's low like it did today.

Of those 13 occurrences, only 4 showed a positive return three trading days later, and the average return was -1.0%. The average maximum loss was three times greater than the average maximum gain over those three days (-1.9% compared to +0.6%). The last seven instances, going back to 1999, have been negative.

Interestingly, though, if we had bought at the close three days later and held on for two weeks, then we would have ended up with 12 winning trades out of 13, with an average return of +2.0%. That would fit with the end-of-year positive seasonality bias.

So there is some conflicting info here - the tendency to see more short-tem weakness after reversals from a new high like we saw today, and the recent tendency to see imminent lows after oversold model readings. I'm not sure which is going to win out this time, so I'll be using the 141 area in SPY (1420 in the e-mini futures) as a guide...preferring to concentrate on longs above there, and (more aggressively) shorts below.

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

ApproachingTheBell

12/07/06 3:25 PM EST

With the push lower this afternoon, the S&P 500 proxies have approached their breakout levels around 141 in SPY and 1420 in the March 2007 e-mini futures.

In addition, our short-term models are now in what could be considered extreme territory. They became even more stretched in late November, but their current readings are on a par with other extremes seen over the past few months. Without exception, the broader market formed a low nearly immediately after the prior occurrences.

So we have what's setting up to be a good test here...if this momentum-based trend is still in effect, then we should by all means see buying pressure come in around here, as this is a classic re-test of a clear breakout pattern with short-term oversold readings.

I noted this morning that if we saw those breakout levels give way, then I'd be more comfortable in treating this as a more normal market instead of a momentum-based one, which essentially means that I would be more willing to try short trades. I don't see a good short setup yet, though - I'd need to see the S&P trade and hold below its breakout level, and our short-term guides relieve their oversold readings.

LunchtimeLull

12/07/06 12:15 PM EST

The small correction in the broader market has been enough to push a few of our intraday guides towards their lower trading zones, including the STEM.MR model for both the S&P 500 and Nasdaq 100.

Given that the S&P has held above its recent highs while these guides have corrected so much, and the models are close to a point that has coincided with short-term lows in the indices over the past few months (there is a bit more room for them to become more extreme, but not much), the logical conclusion would be to expect only minor additional selling pressure, if any is to be seen.

This market has not been conforming to recent norms lately, so whether this is going to be another good short-term buying opportunity is up for grabs. But as the S&P drops towards its breakout level, it's not unfathomable to imagine buyers coming in again.

MidMorningOutlook

12/07/06 10:15 AM EST

Good Thursday morning...Yesterday afternoon I wrote about how our short-term indicators had been correcting, yet price itself (using the S&P 500) had stayed steady above its prior highs. Typically when we get that kind of behavior, it indicates a strong tape.

There have been good reasons to expect more of a pullback, and we got another one yesterday in the form of a very narrow intraday trading range. But things that have preceded short-term weakness in the recent past have not had an effect now.

I would be more willing to skip along with the long side if we were in the last couple weeks of the year. I fully realize that seasonality has been thrown for a loop over the past six months, and if anything it's been working more as a contrary guide than anything else, but it's hard for me to believe that we're going to get any kind of sizable pullback during what has been the best time of the year for many, many years. I guess given the recent record, perhaps that's precisely why we should expect a pullback then, but I don't like to try to outguess consistent patterns.

Frankly, I'm close to waving the white flag at this point for the short-term, since equities are flouting formerly consistent behaviors - even during what we've seen during the strong trend of the past few months. If we see a reversal back below the recent highs (approx. 141 in SPY and 1420 in the Mar 2007 e-mini S&P futures), then it'll appear we're in a more "normal" market again.

Barring that, I'm staying away from a market that defies my risk parameters. Most often, the general equity market is not at all friendly to momentum-based trend-following strategies, but this is what it has been and that is not my style.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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