Snapshot Notes - December 18, 2006

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MONDAY, DECEMBER 18, 2006

PostCloseSummary

12/18/06 5:00 PM EST

One of the more consistent seasonal biases over the years, other than those surrounding holidays and months-end, include the days after an option expiration, which tend to be mostly negative.

The selling often begins right at the opening bell, but today the buyers were able to hold things together for a bit before the major indices rolled over - in a big way when looking at some of the higher-beta sectors.

Those more volatile indices, like the Nasdaq 100 and Russell 2000, are what I have been keying on as important tells for the broader indexes like the S&P 500. One market cliche that actually has some truth to it is that the high-beta indexes act like a "canary in a coal mine" and can warn of impending danger (or opportunity).

With the NDX forming two consecutive reversal days right at its prior top, classic technical analysis would paint a pretty bearish picture, especially given the current state of many intermediate-term sentiment measures. Seasonality is the wild card here, since this time of year has been consistently positive in the past, though in general that discipline has been more unreliable than usual over the past six months.

With the push lower this afternoon, our STEM.MR models for both the S&P and NDX entered true extreme territory, a place where they normally begin to curl back up as the market begins a recovery, or at least see a halt in the selling pressure. So the bulls have what should be a sweet setup here...oversold short-term conditions, with positive seasonality and a strongly trending uptrend. Also, as mentioned earlier, when the NDX has suffered a 1% dip after option expiry, the rest of the week was positive 10 out of 12 times over the past few years.

I'll be watching for the buyers to give it another run early this week, particularly if the NDX dips a bit more towards last week's lows. That would add an additional impetus for buyers (it allows them a tight stop loss below support) and should serve as a buying opportunity. If prices continue to slice lower, however, we will finally have a solid piece of evidence that the market's character is changing and the intermediate-term negatives are taking hold.

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

ApproachingTheBell

12/18/06 3:25 PM EST

After a small lunch-time bounce, the indices rolled over again and the high-beta sectors continue to bear the brunt of the ugliness.

Our STEM.MR models had just entered oversold territory by the time of the prior note, and are now at "maximum" extremes for all practical purposes. They can get stretched a bit more, but when they see the current kind of reading, they most often begin to curl upwards again as the markets rebound.

On Friday I noted how the day following an option expiration tends to be negative. After that, there is no longer any negative bias. As a matter of fact, the Nasdaq 100 trust (QQQQ) has been negative by 1% or more the Monday after an option expiry 12 times since 2003. Buying that close and holding the rest of the week resulted in 10 winning trades with an average of +0.9%.

When we combine that stat with the oversold models, positive overall trend and upcoming "Santa Claus" seasonality, the ingredients are here for another rally attempt. I'll be looking for that, particularly if the NDX dips to 1770 or so by tomorrow morning.

LunchtimeLull

12/18/06 12:25 PM EST

Following option expirations, we often get weakness right off the bat, but it took a little while longer today as the indices held their ground for the first 1/2 hour or so.

The high-beta indexes continue to flash warning signs, with the Russell 2000 getting hit again - it's even close to taking out last week's low. And the pattern on a daily chart of the Nasdaq 100 should have classic technicians all atwitter with bearish thoughts as it carves out consecutive reversal days near its prior peak.

This continued selling pressure has pushed our short-term STEM.MR models into oversold territory, with the one for the S&P 500 hitting its most stretched reading since the late November low. It's unusual to see such an extreme reading with the S&P off only a handful of points from its high, so we'll see if this is one of the pieces of evidence I've been waiting for about a change in market character. If not, then given the trend and seasonality and these short-term readings, bulls should quickly make a stand.

MidMorningOutlook

12/18/06 10:15 AM EST

Good Monday morning...The choppy move lower from the opening bell on Friday was enough to move our shortest-term guides away from overbought extremes and some, like the Cumulative TICK, actually registered an oversold reading.

Like a strong market should, we're seeing the equity averages tack on more gains off this minor oversold reading, something that has been par for the course the past few months.

One difference this time around is the lag so far in higher-beta indices and sectors, most easily seen in the Nasdaq 100 and Russell 2000. The best upside moves come when all of the major indices are acting in concert and setting new highs together. Besides the exceptional sentiment extremes we're seeing, this intra-index divergence is something to worry about, but like sentiment, it's best to wait for some kind of confirmation from price itself before acting. That confirmation will come when we see a change in character - when the market doesn't rally off of short-term oversold conditions, for example. We have seen precious little of that kind of evidence since the July low.

As for the short-term, the opposing forces of extreme sentiment (a market negative) and seasonality (a market positive) have me shortening my time frame more than usual and trying to take advantage of day-to-day opportunities, like we saw Thursday on the upside and Friday on the downside. I don't see anything compelling at the moment from either direction and am standing aside until something comes up.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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