Snapshot Notes - October 4, 2007

As of:

SPX 1523

After the good beginning to the new month, we started to see some readings trickle in suggesting that the "dumb money" was perking up. While those kinds of readings aren't the death knell for a rally, we typically do see some backing off when they occur.

I'm writing specifically about the Rydex Beta Chase and Odd Lot Purchase Percentage indicators, and this morning we added the AAII sentiment survey. The latter had been stuck in a stagnant range for several months, but this week we saw a big swing back to excessive bullishness among those investors.

In the past few years, when the market had improved enough that the AAII folks swung to the "too few bears" side of the fence, the market soon either entered a moderate decline or gone into a mode of choppy upside progress.

Given those concerns, I've held back on an anticipated long-side trade in the Nasdaq 100, which I've been considering due to both its recent out-performance and the oversold reading in the STEM.MR Model for that index. It might seem odd to be writing about overbought and oversold indicators in the same comment, but that model is shorter-term than the others I wrote about.

There did seem to be an opportunity to get in on the NDX today, but again I hesitated, this time due to tomorrow morning's release of the monthly jobs report. The trading of the past few days has closely mirrored that of last month, after which we saw a big move lower when a weaker-than-expected report was released. As I noted at the time, there isn't much of edge in trying to game the report itself, but there is in trading the reaction to the report, and it proved to be effective once again last month.

Despite the risk of trying to find a "perfect" entry and over-thinking a trade, I don't like taking short-term positions ahead of an edgeless unknown whenever possible, so for better or worse I'm going into tomorrow's number flat and we'll just have to deal with the aftermath of the reaction. The worst-case scenario would be a large gap up, but frankly I don't know if that would be more likely caused by a good or bad employment report. Either way, we'll cross that bridge when we come to it.

As of:

SPX 1523

HELP ARCHIVE

Today's session has been another one with much ado about nothing, as the major indices carve out narrow ranges ahead of tomorrow morning's jobs report.

The pattern we've seen the past few days is similar to last month's, where we had a big spike up to begin the month, a couple of days of lazy consolidation, then the big move once the jobs numbers were released.

That big move happened to be to the downside, but I have no edge in trying to determine if tomorrow's will be as well. Both good news and bad news lately has resulted in higher stock prices, but there's no telling if that might continue tomorrow. More game-able is the market's reaction to the news. As I went over after last month's report, big reactions either way tend to lead to a move in the opposite direction in the days following that, so that will be something to consider as we see tomorrow's response.

I've been enamored with the idea of a long position in the Nasdaq 100 given the oversold nature of the STEM.MR Model for that index. I've held off due to some other readings of excessive optimism that have triggered in other indicators the past two days, and the still-small correction in that index.

If it wasn't for tomorrow's jobs number, I'd likely have put on at least something on the long side this afternoon, but I don't like to trade ahead of unknowns that have a high likelihood of moving the market. So as tough as it is, I'm going to keep sitting on my hands in trading accounts and wait for tomorrow morning's release.

As of:

SPX 1523

HELP ARCHIVE

Good Thursday morning...we begin the day with some weakness in the major indices and most of the broader market sectors. Housing, the recent leader, is seeing a little air taken out of the balloon, but more troubling to me is that semiconductors are once again in the doghouse.

One of the things we've had to deal with quite a bit this year is shifting trends beneath some of the data we cover. The elimination of the uptick rule was one, and some odd behavior in the Commitments of Traders data was another.

One I haven't written much about is the AAII sentiment survey. This poll of individual investors had been my favorite survey, and one of the reasons was because it was relatively "noisy". It had a lot of movement from week to week, and that helped us to identify several solid opportunities over the years.

Ever since about April of this year, the survey got eerily quiet. The week-to-week movements quieted down, and that has resulted in fewer extremes than we've seen in the past. And when these surveys don't give an extreme, they're mostly useless to us.

That seems to be changing. The latest responses, released this morning and including opinions taken through Wednesday evening, showed that these investors had caught the bullish bug and were as optimistic as almost any other time this year.

An interesting factor in the AAII data is that the optimistic peaks have become less and less extreme as the bull market wears on. These guys and gals were their most optimistic in early 2004, and each subsequent peak in bullishness has come at a lower level.

If you draw a trendline across those peaks in bullishness (or simply look at the adaptive trading bands we use for the data), you can see that we could now consider this survey to be showing excessive optimism, and the last time we saw one of these extremes was right before the February drop in stock prices.

Just because it may be at an extreme does not mean we have to see a decline like February, though - the survey also showed excessive bullishness in late 2005, yet the market continue to chop higher for months before seeing those gains erased during the summer of 2006. That's the nature of extreme bullishness in strong bull markets - prices sometimes (often, in fact) continue to rise for weeks or months afterwards before much of that gain gets temporarily wiped out during quick, severe sell-offs. That isn't just the nature of the past few years, it is a common phenomenon when looking back through history.

These kinds of sentiment extremes provide a good "heads-up"...it may not necessarily be a good idea to sell long positions right away, but it is recommended to snug up stop orders, decrease leverage, and be alert for the possibility that some recent gains could evaporate in a hurry.

For the shorter-term, I've been struggling with the idea of a short-term long-side trade in the Nasdaq 100, based on the seemingly impending oversold signal from the STEM.MR Model for that index, and its recent out-performance. My struggle has been with the idea that the model may be close enough to a buy signal to at least dip a toe in, so I'm not sure if I'm being patient (which is good) or trying to be perfect (which is bad).

What's been holding me back are the superficial dip the NDX has undergone, and the recent signs of excessive optimism from some of our indicators like the Rydex Beta Chase Index and Odd Lot Purchases, not to mention this week's AAII survey. I'm going to like the NDX as long as it's anywhere above 2050-2060, so it's just a matter of determining how far it may dip before a potential challenge of the recent high. Again, maybe I'm trying to be too perfect, but as of now I think the risk of a further short-term slide is greater than the probable reward of a test of that high.

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