Snapshot Notes - September 20, 2007

As of:

SPX 1529

One thing I've learned over the years is that saying anything negative about Gold brings about catcalls like nothing else. Hell hath no fury like a Gold bug scorned.

This weekend, I showed historical performance in various assets, including Gold, after an initial cut in rates by the Federal Reserve. One of the takeaways from that was that Gold did not automatically rise consistently after a rate cut like many assume, and in fact when looking out three months or longer, it was usually solidly negative.

Besides the historical performance following discount rate cuts, something else bugs me about jumping on the long side of Gold for anything other than a trade. We compute a Public Opinion score for several commodities, including Gold, which measures bullish opinion among eight sentiment surveys and weights them according to their historical accuracy at measuring price extremes.

The current figure for Gold is 87%, roughly meaning that out of the entire sample of survey respondents (which is quite broad), 87% think Gold is going higher (click here for chart). That has been matched only three times since 1990: July 1993, December 2003 and May 2006.

Each time, Gold managed to scratch its way higher over the next few weeks, climbing an additional +4% on average. But then over the next two to six months, it lost an average of -16%, and not less than -12%.

I suspect that when the new Commitments of Traders report comes out tomorrow, we may see that speculators have followed up on all that bullish opinion by becoming even more net long the metal. As of last week, they were making their way to an extreme but hadn't quite made it there. If we see speculator positions move above the red trading band, it will be another factor suggesting any additional upside is temporary.

Back in equity land, for the past couple of days I've been hesitating to jump on board the long-side bandwagon due to the tendency to see nothing but chop at best following days like Tuesday. With an extreme reaction to an economic event, and overbought short-term indicators, it didn't seem like the best risk/reward setup.

More interesting would be a short-term decline towards 1500ish on the S&P 500 cash index that relieved that overbought pressure. Given the eagerness of buyers, I wasn't sure how much of a rest we'd actually get, and I'm still not, but today's mild decline was enough to push our short-term guides not only out of overbought, but actually into oversold territory.

One more factor to consider here is seasonality. Option expiration is tomorrow, and that has not been kind to stocks during September. Since 1990, the week following option expiration has shown a positive return in the S&P only 2 out of 17 times.

Taking out the week following 9/11, the average return for the week was -1.3%, with an average maximum gain during the week of only +0.6% compared to an average drawdown (i.e. loss) of -2.5%. Every one of the last five Septembers has been negative following expiration. But waiting for a week, then buying and holding for a week (usually the last week in September) resulted in 12 winners out of 17 years, so the weakness tended to be isolated to the period immediately following expiration.

This is a very solid edge, especially as far as seasonality goes, and I'm a bit taken aback by it. I didn't think it was as strongly negative as it has been. Seasonality for me is very, very rarely cause to take or avoid a trade on its own - I consider it more a gentle breeze either for a trade or against it - but this one is a strong edge and makes me less eager to be an aggressive buyer.

Other than the seasonality, the setup looks pretty from the long side, particularly if we would happen to get closer to 1500 on the S&P. Ideally that would happen Monday, as the bulk of selling pressure after expiration weeks tends to be concentrated earlier in the week rather than later. So I'm still looking for a good long entry, it may just take a bit longer than I was thinking.

As of:

SPX 1529

HELP ARCHIVE

During the August tumult, one of the outside factors many traders were watching was the level of the Japanese Yen versus the US Dollar and the Euro. The thought was that if traders were covering their Yen short trades, then it was a sign of risk aversion - which could lead to lower US stock prices.

The correlation between the Yen and the S&P 500 since late last year has been phenomenally strong, so it's something that I, too, have been watching. Notably, the Yen is soaring today, up well over 1%, but yet the S&P isn't taking that much of a beating.

Since the beginning of this year, there have been 10 days when Yen futures rose by more than 1%. On those same days, the S&P 500 dropped 6 times, and its average return was -1.3%. The four times it rose, the average return was a meager +0.4%, while on the six losing days the average was -2.4%, and all of them showed a decline of at least -1.4%.

Today the Yen is up more than 1%, yet the S&P is down only about 0.4% as I write (obviously it could still drop into the close and lose more than 1% to fit in with the recent precedents).

Is this a sign of strength in equities, or a hint that there might be some trouble to come? There's no way to tell for sure, of course, but we can look at the four other days this year when the S&P didn't drop at least 1% despite a 1% rally in the Yen and see if it led to anything conclusive. Unfortunately, it didn't.

Two of the four times, the S&P rose over the next week, rising more than 1% each time. But the other two times it fell, one of them hard. The dates are 2/15/07, 3/20/07, 6/19/07 and 8/16/07.

We're also seeing long-term Treasury Bonds getting hammered. While that should be no real surprise - bullish sentiment on Bonds has been at an extreme lately as you can see from the Bonds section of the site - there has been a relatively consistent pattern of large Bond declines coinciding with negative equity returns.

That doesn't mean that large jumps in yields necessarily *predict* equity weakness, though. In fact, there have been 13 days in the past decade when Bond yields rose 3% or more on a single day, and a week later the S&P 500 showed a positive return 10 of those times by an average of +0.7%.

So the fact that US equities are holding firm in the face of a ramp in Bond yields and the Yen is unusual, especially when looking at data over the past year or so. But after checking some of the precedents we have, it would be tough to make the argument that these developments are predicting future weakness in stocks - perhaps just the opposite if anything.

The weakness we have seen, however mild, has been enough to take our more sensitive guides away from the "excessive optimism" readings that had triggered by Wednesday morning. My thought has been that given the positive longer-term studies that have been triggering over the past month, and the tendency to see a bounce after the first test of a breakout area, any decline towards 1500 on the S&P 500 cash index should lead to a good opportunity on the long side.

With the seemingly eager nature of buyers, I wasn't sure if we'd see that deep of a retracement, and I'm still not, but I don't think we've seen enough backing off yet to make sense to dip in on the long side.

As of:

SPX 1529

HELP ARCHIVE

Good Thursday morning...we begin the day with a gap down open in the major indices that got gobbled up quickly, and mixed performance in the broader sectors. The big gainers of the past few sessions, like housing, banks and retail, are the ones lagging today, so obviously there's some profit-taking kicking in.

We left off yesterday with a market that had done well consolidating Tuesday's enormous gains, which is pretty typical for a market that experienced the kind of readings we got on Tuesday.

When we looked at the historical performance following days like Tuesday, whether that involved the magnitude of the price rise, or the extremely positive lopsided skew in volume, or the jump on news of a Fed rate cut, the pattern was fairly clear - choppy conditions in the short-term, then a resumption of the rally over the next several weeks and perhaps months.

Because of that pattern, and a slug of overbought signals from our more sensitive guides, I wasn't all that willing to try to chase prices higher after Tuesday afternoon, and that's still the case. The indices have recovered well this morning from a down open instead of selling off even more, which is yet more evidence that there are a host of buyers out there wanting to step in on even momentary weakness.

I have no desire to try shorting on any time frame in this environment, so I'm looking exclusively at opportunities to get in on a high-probability, low-risk long. A more ideal scenario would be a decline towards 1500ish on the S&P 500 cash index, as the first move towards a defined breakout area is usually a good bet for a short-term rebound. The weak opening was quickly erased by eager buyers, so perhaps we're just not going to get an "easy" long entry, but I just don't think we're going to see sustained upside unless prices back off more, and more time goes by.

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