Snapshot Notes - October 8, 2007

As of:

SPX 1523

When we got the jump in stock prices Friday morning based on the jobs report release, we went over some stats related to extreme reactions to economic numbers that were pretty clear - those reactions tend to be consistent contrary indicators.

By that, I mean that in the short-term, we very often see stock prices move in the opposite direction of the initial reaction. Friday afternoon's rally was more than we typically see after that kind of a gap open, but today's give-back is more in line with history.

In the process, our more sensitive indicators have backed off their suggestion that we're seeing excessive optimism, and indeed a few of them were giving the opposite indication by this afternoon. That has moved the STEM.MR Model (for the S&P 500, at least), down towards oversold levels for the first time in a couple of weeks. It might seem odd that we could be getting oversold signals with the S&P off only a handful of points, but as I pointed out late last week with the model for the Nasdaq 100, they are constructed so that it is easier to get oversold signals in strong markets than weak ones.

That suggests that any further deterioration over the coming day(s) in the S&P should be temporary, unless we're about to undergo a more serious pullback. By the time the model reaches this kind of a reading in a strong market, we typically see a rebound beginning within the next couple of hours. If that doesn't happen, and prices keep declining, then that's most often an indication that the momentum has stopped and we're going to see even lower prices in the week(s) ahead.

Given these readings, we should see the S&P make another run at its old high relatively quickly. I outlined a couple of concerns this morning in relation to the lagging advance/decline line and excessive speculation in the Internet sector, but those are longer-term in nature and wouldn't at all preclude another short-term push higher.

As of:

SPX 1523

HELP ARCHIVE

It's been another split session today, with several sectors getting hit hard, but technology standing out to the upside yet again. With much of fixed income closed for trading today, equity volume is very low. We don't often see large traders make big bets in stocks when they can't make relative price decisions via other asset classes.

The choppy day has been enough to relieve the "excessive optimism" readings from our short-term guides, and in fact a few of them have dropped enough to tickle oversold levels, at least the ones focused on the S&P 500. If we get some downside follow-though tomorrow morning, then I suspect we would get a buy signal sometime tomorrow from the STEM.MR Model.

Breadth is lagging badly, even though the price losses in the major indices aren't that bad. This morning I touched on the performance in stocks when the advance/decline line lags as the S&P hits a new high, and this is something to keep monitoring. If we continue to see indexes like the S&P hit highs without the a/d line following suit, then I'll be much more circumspect about trusting the move higher in the indices. These divergences can play out over long periods of time, but it has been relatively rare to see sustained upside rallies in the broad stock indices while the a/d line is dragging.

For now, I'm letting the digestion of Friday's jump play out. As we discuss every time it happens, extreme reactions to economic events have a tendency to lead to moves in the opposite direction over the short-term, and today is a prime example of that. The way our short-term guides are tossing away those overbought conditions, though, we shouldn't have to wait long before another possible buying opportunity is at hand.

As of:

SPX 1523

HELP ARCHIVE

Good Monday morning...we begin the new week with lackluster trading as bond trading is mostly closed for the Columbus Day holiday and stock volume is coming in lighter than normal. Retail and Brokers are among the losers this morning, while Internets are taking the top sector-performance slot - I'll have a bit more on that sector later in this note.

One of the pieces of market data that's starting to get around is the negative divergence we're seeing in broad-market advance/decline lines despite many of the major indices hitting new highs. The a/d line is simply a cumulative addition of each day's advance/decline number, and typically it also hits a high when stocks in general do too.

Over the past decade, I show that the S&P 500 has hit a new yearly high 169 times. Of those, the NYSE a/d line also hit a yearly high on the same day 94 times. Over the next month, the S&P showed an average return of +0.3% with 57% of the days showing a positive return.

If we then check again for any time the S&P hit a new high, but the a/d line was at least 2% below its own high, then we see that the next-month return in the S&P averaged a terrible -1.6% with only 37% of days showing a positive return. These days were almost exclusively in 1999 and 2000, though it also occurred in late November 2005. At that point, similar to now, the indices rocketed out of oversold conditions and hit new highs. After this divergence occurred, though, stocks went into more of a lurching uptrend with much wider swings, before ultimately losing all of those gains during the summer of '06.

It's a little easier trading indices like the S&P 500 when most stocks are in agreement - with most of them either rising or falling together. When we get these odd junctures when some are rising and some are falling, it becomes more difficult to trust the indices. That difficult is highlighted now as the S&P is at a new high but the a/d line is well below its own high.

One of the leaders of the recent resurgence has been technology, and particularly internet-related issues. That hasn't gone unnoticed by traders, and it's interesting to note that assets in the Rydex Internet fund have skyrocketed, as you can see from the chart we update daily on the site.

With assets in the fund ballooning to just under $57 million as of Friday, we're seeing the most interest in that sector since November of last year, right before the fund went into a several-month consolidation.

Historically, this kind of rush into the fund hasn't been all that great for current holders. Whenever assets have reached $50 million or more, the one-month return in the Dow Jones Internet Composite averaged -4.2% with 38% of days showing a positive return. The three-month return averaged a dismal -24.5% (due to a slug of occurrences in 2000), and amazingly, only 1 day out of 57 in the sample showed a positive three-month return.

The index was very volatile, with the next three months showing a maximum gain of +10.3% on average, compared to an average maximum drawdown of -33.3%. So while it's generally a good sign that traders and investors are increasing their risk appetite, we're reached a point where that appetite has perhaps grown a bit too large and a period of digestion is due.

As for the short-term, the indices have done quite well the past few weeks and on Friday we saw fresh breakouts. In the process, they triggered a batch of overbought readings among the more sensitive indicators that we follow, which typically means that any additional upside follow-through will likely be given back in the days following. Trying to short a market sitting at new highs is a tough game, but so is chasing prices higher, so I'm going to remain flat for trading positions here and see how we muddle through these newly overbought conditions.

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