Snapshot Notes - October 16, 2007

As of:

SPX 1545

Over the past week or so, we've been going over a few longer-term measures of sentiment that were showing extremes in bullishness. While they didn't have a good record at preceding an imminent impact on prices, they were consistent in giving a heads-up that a continued low-volatile, sustained uptrend was unlikely.

Over the past few days, more data has emerged that painted a similar picture, if not even more dour. I touched on a gauge of small-trader option sentiment on Monday morning, and how those traders were positioned in a more optimistic manner than any other time since 2000, which has troubling implications for our current market.

On a shorter-term basis, though, there are some potential positives. We've now had two bad days in a row, which typically precedes better times ahead (at least temporarily). Over the past four years, whenever breadth on the NYSE has been as bad as it was yesterday and today, then the next three days showed a positive return in the S&P 500 71% of the time.

This afternoon I went over somewhat similar stats, except related to the looming option expiration. Again, the results for the next few days were consistently positive, and significantly better than random.

In addition to the usual trading challenges, we've now entered earnings season, and that often increases the probability of a meaningful gap between one day's close and the next day's open. We'll just have to deal with those as they come. Tonight's reports from YHOO and INTC have been taken well by investors, though we know more than too read a lot into initial knee-jerk reactions, and much could change before tomorrow's open. Still, looking out over the next few days, the risk/reward seems to be pointed to the long side.

As of:

SPX 1545

HELP ARCHIVE

Earlier, I mentioned that a moderate potential positive could be that option expiration weeks, like we're currently in, have tended to enjoy a modest (but consistent) positive bias lately, particularly when there is a weak beginning to the week.

Digging a bit deeper, I looked for any time since 1983 (when the CBOE began trading options on the S&P 100 and S&P 500) that the S&P 500 dropped at least 0.5% on the Monday and Tuesday of expiration week. Looking at returns for the remainder of the week, they were positive 9 of 11 times by an average of +1.8%, with a +2.9% average maximum gain and -0.9% average maximum loss.

The last four instances, dating back to 2000, were all positive and averaged a return of +3.8%, with a max gain averaging +4.6% and a max loss that averaged only -0.4% (that is excluding the week following 9/11/01).

Ignoring how the market started the week, over the past two years the S&P has done quite well from the Wednesday of expiration week through Friday. 19 of the past 24 expirations have shown positive returns during that time (including 10 of the past 12), and a maximum gain that was more than three times the maximum drawdown on average.

That's a fairly solid edge, and when we combine it with the oversold readings from our short-term guides, it suggests that the risk/reward remains pointed to the upside. I'll reiterate that I continue to be very troubled by some of the recent signs of excessive optimism that we've discussed in recent comments, so I don't want to get married to the idea that we *have* to rally, but for a trade the long side still looks better for the remainder of the week. Earnings releases are going to start heating up beginning tonight, so we're likely going to see an increasing number of large gap opens in both directions, but that's just something we'll have to deal with as it happens.

As of:

SPX 1545

HELP ARCHIVE

Good Tuesday morning...we begin the day with weakness across the board in the major indices, and almost all the broader market sectors . Financials are leading us lower - not a good thing unless they begin to bounce from oversold conditions, which are rapidly approaching for many of them.

Over the past several sessions, we've been going over some precedents related to last week's gap up opening on Thursday and subsequent reversal. The market played out in rhythm with those past occurrences, but the consistency stopped after a couple of trading days and we can't really rely on them at this point.

What has attracted my attention now is the oversold nature of our shortest-term guides, the moderate positive seasonality of option expiration weeks (particularly in the middle of the week), the tendency to bounce back after bad breadth days like yesterday, and the still-positive technical behavior of the major indices.

Detracting from those positives are the signs of excessive speculation that have built up. That's somewhat natural after a move like we've seen over the past couple of months, but that doesn't mean it's not troubling. Market performance after speculative excesses tend to be sub-par, if not outright negative. The latest bit of worrisome data is something I went over yesterday morning related to small options traders, who entered the week with their most-bullish positioning since 2000. The last time we saw excessive optimism from those folks was late July, which was...uhh, not good.

So I'm trying to balance those positives and negatives. Given that we haven't seen the major indices do anything "wrong" since the August lows, and the tendency to bounce back after oversold STEM.MR Model readings and bad breadth, I'm giving the benefit of the doubt to the long side, at least when looking out over the next several sessions.

I'm extremely troubled by the small trader option data that we went over yesterday, as well as some of the other signs of speculation we've gone over, so I think it would be a mistake to try being aggressively long, or being too stubborn if we continue to roll over. The S&P 500 cash index has lost the 1540 area as I type, something I did not want to see, so we'll have to wait and see how traders react to the breach of that potential support area.

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