Snapshot Notes - October 26, 2007

As of:

SPX 1511

When we began this week, we were coming off of severely oversold short-term conditions, and to top it off we were treated to a relatively large gap down opening on Monday.

Traders were atwitter with thoughts of a Black Monday repeat, but as we went over at the time, historical precedent strongly suggested quite the opposite. The equity market has had an extremely consistent tendency to rally off of conditions like that - not decline, and much less crash.

After we rebounded for a couple of days, the guides we follow became much more murky, making it tough to find an edge either way. We got a couple of days of nothing but chop after that, which set us up for what looked like another good-looking try at the long side.

Going into the past couple of days, some positives had popped up, such as the idea that last week took its toll on at least part of the investment population (as determined by the AAII sentiment survey), and we were also heading into a six-day stretch that had been exceptionally positive over the past decade and beyond.

Once the S&P 500 cash index broke out of the little "w" bottom it was trying to form, and backed off of its gap up opening in typical fashion, a re-test of 1520 was all that was needed for buyers to come back in, and it took us back to new intraday highs by the closing bell.

The latest Commitments of Traders report, released this afternoon and including positions as of this past Tuesday, showed that commercial traders (aka the "smart money") increased their net long position in the major equity index futures for the first time in over a month, from $8 billion last week to $12 billion this week.

Most of the change was in the S&P 500 futures, in which commercials remain extremely net long, and which has historically been a positive indication going forward. The interesting thing about the way they are positioned is that in stark contrast to the S&P, they are very net short the Nasdaq 100, something that has preceded declines in that index with regularity over the past few years.

I have included a chart of combined commercial positions for the NDX below (using both the full contract and the e-mini, adjusted for the different sizes of the contracts), with arrows highlighting past bullish and bearish extremes.

Doesn't look very good for our current situation, does it? Frankly, I'm not quite sure what to make of this, given that commercials are so net long the S&P 500 contracts at the same time they're very net short the NDX. Perhaps it's as simple as expecting the S&P to out-perform the NDX going forward, but I'll have to noodle this over the weekend to see if we can't wriggle some kind of edge out of the data.

As we stand now for the short-term, our more sensitive indicators aren't showing signs of excessive optimism quite yet, so the technical picture looks good, sentiment looks OK for now, and seasonality looks about as good as it ever does. Unless the S&P breaks back under 1520 on the heels of a negative earnings reaction or whatever other reason, I don't see much reason why we can't head at least moderately higher in the coming days.

As of:

SPX 1511

HELP ARCHIVE

This morning we went over again a couple of positives that were suggesting higher prices over the short-term. With at least some modest signs of traders getting too negative from last week's decline, and looming positive seasonality, a breakout over 1520 on the S&P, should it hold, seemed to present a decent long-side attempt.

That breakout came in the form of a gap up opening, which it very rarely pays to chase. The S&P did back off about 10 points from the open, nearly closing the gap and again testing that 1520 area. That's about all it took, and we've once again seen a v-shaped afternoon rally. Unfortunately, I had a small family emergency and I missed the bulk of the afternoon ride.

I can't find much to pick on here. We've already gone over the potential reasons for further upside, and our more sensitive indicators aren't yet showing signs of excessive optimism. So the technical picture looks good, sentiment looks OK for now, and seasonality looks fantastic. Barring another negative reaction to earnings or economic reports, both of which are going to keep subjecting us to overnight gap risk, I don't see much reason why we shouldn't plod higher over the coming days. I would back off such a sanguine view if the S&P loses that 1520 level, and may become outright bearish if it can't hold 1490.

As of:

SPX 1511

HELP ARCHIVE

Good Friday morning...we begin the final day of the week with yet another gap up opening, and positive performance in almost every sector I follow. Despite Microsoft's large gap up, the Nasdaq 100 hasn't been able to gain much traction, which is curious. MSFT alone is currently accounting for 14 of that index's 24 point gain this morning.

Yesterday, we went over a few potential positives for the short-term. After today, there is a week-long stretch of what has historically been very positive seasonality across sectors and the market as a whole, with the S&P 500 tracking fund, SPY, showing a positive return every year for the past 12 years from the last three trading sessions in October through the first three in November.

We also saw a hint that investors took last week's decline seriously (too seriously, perhaps). The latest AAII sentiment survey, after showing signs of excessive optimism a couple of weeks ago, did an about-face and is now suggesting that there is too much bearishness.

Both of those are pretty good signs, but I wanted to see either one of two things before trying the long side in this treacherous earnings- and economic-data dependent market. I was looking for either some short-term oversold readings among our more sensitive indicators (preferably with the S&P 500 cash index holding above 1490 at the time), or a breakout in that index over 1520 that was able to hold for at least a few hours.

We got two "close but no cigar" moments yesterday. The S&P did break out over 1520 in the morning, but it quickly failed. And then we got some kinda-sorta oversold readings in our intraday indicators towards the close. Perhaps that should have been enough to trigger a long-side try, but with an avalanche of earnings after the close I didn't feel the risk was worth it, as the probability of at least a 5-10 point gap in the S&P was high.

Indeed we did get that gap, and it turns out that it would have been in our favor. That's been the case often over the past two weeks, but I'm taking refuge in the idea that just because it would have worked in hindsight doesn't mean that it would have been a prudent trade knowing what we knew then.

In any event, the gap up open in the S&P is one of the largest we've seen this year. In fact, it's one of the larger ones of the past few years, especially considering that we're not emerging from a prolonged decline. Since the bear market low in the fall of 2002, I can find 16 other instances when the S&P gapped up as much as it did this morning, while in an intermediate-term uptrend at the time (defined simply as a rising 50-day moving average).

Buying that open and holding 'til the close resulted in only 4 winning trades out of the 16 attempts, with an overall average return of -0.4%. Not one of the past seven trades, going back to October 2003, was able to close any more than 0.3% higher than the open. The returns looking out a few days later weren't any better or more consistent.

This is nothing new, of course, as we've gone over gap stats like this several times just in the past couple of weeks. That's what happens during earnings season, and for the most part the market has stayed true to its historical tendency to struggle after such large gaps.

So I'm not intending to chase this gap open this morning, but I do remain interested in the possibility of a long trade if the S&P 500 cash index can hold above 1520 today. As noted, we have some very good seasonality coming up (though it will be interrupted by the end-of-month FOMC meeting), so if we can breakout and hold this gap for the most part, then we should be able to see even higher prices going into the FOMC meeting next week.

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