Snapshot Notes - September 21, 2007

As of:

SPX 1529

After the FOMC decided Tuesday afternoon to cut their short-term target rate, and equities subsequently jolted higher, I was harping on the fact that broad indices like the S&P 500 tend to consolidate for a few days instead of continuing to ramp higher.

We got a couple days of drifty prices, then by Thursday afternoon the indices had settled back enough so that some of our more sensitive indicators, including the STEM.MR Model, were even giving oversold readings. Given that model reading and the idea that markets tend to bounce on the first retracement after an obvious breakout, the setup was starting to look good for at least a short-term long trade.

The lone problem with that idea was seasonality. I normally don't put much weight on seasonal statistics, other than around holidays, but historical equity performance following September expirations has been consistently horrid when looking at the week following expiry.

Earlier today, I looked at expiration from a variety of different angles, and they all turned up the same conclusion - we should expect weakness following today, at least in the very near-term. The data was consistent enough to have me backing away from the seemingly good setup we were getting from a technical/sentiment standpoint.

With the gap up this morning, backing away from the long side based on seasonality seemed like a silly mistake. Even after the late-day fade, that could still be, and if we ramp higher from here I'll be giving myself a royal kick in the behind. I rarely let seasonality trump the other stuff we monitor on the site, but again this one surrounding expiration was consistent enough for me to do so.

If we are going to get any expiry-related weakness, then it should come early next week - when the S&P has been up this much on the day of an expiration, the following Monday was positive only 3 of 14 times since the bull market began in the fall of 2002.

The latest Commitments of Traders data, released late this afternoon and covering positions as of this past Tuesday, showed the same thing it has been for a couple of months. "Smart money" commercial hedgers increased their already-record net long position, now totaling $42 billion, and "dumb money" small speculators continue to hold one of their smallest net long positions in seven years. As I note every week, this should be a bullish indication for the market going forward, assuming this data is not being corrupted by swap traders or other Wall Street esoterica.

I mentioned Gold yesterday, and the new CoT report did indeed show a jump in speculator long positions, but not by as large a degree as I thought we'd see given the rampant bullish opinion. Still, I think the metal has maybe another 3%-5% gain in it over the next couple of weeks, max, before suffering enough pain to make recent buyers regret their decisions.

As of:

SPX 1529

HELP ARCHIVE

Since yesterday afternoon, I've been struggling with the conflicting outlook given by the current technical/sentiment setup versus seasonality.

In the vast majority of cases, I will side with a good sentiment setup hands down over seasonality. The latter is typically just not consistent enough for me to consider altering a trading plan.

But I was unnerved by the consistency with which stocks have had trouble following September option expirations, showing a positive return during the next week only 2 times during the past 17 years.

So it's a battle of sentiment vs. seasonality. To try to find any possible precedents, I checked for any time the STEM.MR Model was oversold heading into a September expiration. The only prior instance was 2005, and true to (seasonal) form the S&P lost 1.5% the next week.

I then checked any expiration, not just September, and again weakness prevailed. Out of nine occurrences, three times the S&P showed a positive return over the following week, despite coming into expiration Friday with an oversold model reading.

I don't want to harp on this one theme too much, but I next checked for any time expiration Friday was positive by 0.5% or more in the S&P, regardless of whether or not we were short-term oversold. When so, Monday was up only 3 out of 14 times since the bear market low in October 2002.

That's little comfort as the S&P is up 0.7% today and continues to make new intraday highs as I write. Despite those gains, the STEM.MR Model is still around its oversold level due to a lack of consistently high TICK readings, and a still-neutral Price Oscillator.

It looks pretty clear that paying so much attention to the potential seasonal negative was a mistake, assuming these gains hold, but at this point I still don't think it makes sense to chase prices higher. If we're going to see weakness due to expiration, then it should come early in the new week, so we'll have see how things look then.

As of:

SPX 1529

HELP ARCHIVE

Good Friday morning...we begin this option expiration day with a largish gap up open in the major indices and mostly positive sector performance. Housing, banks and retail are lagging again, so it's pretty clear that there is still something of a profit-taking mentality out there after Tuesday's rocket ride.

Despite their reputation for being volatile, option expiration days actually tend to be quite the opposite, so it's relatively rare to see a large gap open on the day options expire.

In any event, there have been 17 times since 1995 when the S&P 500 proxy, SPY, gapped up 0.5% or more the day of an expiry. Buying that open and holding until the following Monday's close yielded only 4 winning trades with an average return of -0.5%. Only one of the last ten instances showed a positive return.

Combined with that, I showed some stats yesterday about the weeks following September option expiration. Those results were consistently weak, with only 2 of them showing a positive return out of 17 attempts.

I'm not a big fan of relying too much on seasonality, but these stats surrounding option expiration are quite solid. I mentioned yesterday that other than the seasonality thing, it looked like we had a pretty good setup for a long trade. The first retracement back towards a breakout area (like 1500 on the S&P 500 cash index) tends to lead to at least a short-term rally, plus the STEM.MR Model had backed off enough to cycle into oversold territory.

It's tempting to say "seasonality be damned" and buy anyway based on the idea that we triggered an oversold pullback from a breakout. I'm not prepared to do that just yet, though - the consistent negative seasonal following expiry is just too unnerving, as is buying into a gap up open near the prior days' highs. If we take off to the upside, I'll be kicking myself for missing a good trade, but as it stands the risk/reward just doesn't look good enough.

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