Snapshot Notes - November 2, 2007

As of:

SPX 1511

Coming into this week, we were getting mixed messages from many of the indicators and studies that we watch. On both a short- and intermediate-term time frame, the cross-currents were suggesting that a choppy market was the most likely scenario going forward, with neither gains nor losses likely to be sustained.

We began the week with some moderate upside, then the typical positive drift into the FOMC announcement. As per usual, we got a couple of violent whipsaws after they revealed their target rate, then a trending move into the close. The reaction in stocks and bonds was extreme enough that it triggered the "Fed reversal' pattern, suggesting that it would likely be a mistake to try to chase prices higher on Wednesday afternoon.

The reversal came quicker than usual, as all of the post-Fed gains were given back before the markets even opened for regular trading on Thursday, and then it got a whole lot worse. The price declines and breadth statistics for Thursday were horrible.

During up-trending markets, especially during the fourth quarter, those kinds of "puke" days tend to be great signs for those looking to put money to work on the long side. We've encountered these kinds of setups time and again over the past few years, and for the most part they've played out well.

The unusual thing about this one is that I can't find all that much to get excited about. Looking at the data from several different angles (the magnitude of the price drop, the skew in volume and breadth, our short-term sentiment readings), I couldn't find much that suggested yesterday was a good buying opportunity other than perhaps for a next-day rebound kind of thing. Even when we factor in our current positive seasonality and the general up-trend we're in (and the fact that the S&P 500 cash index held above the 1490 support level that is becoming an increasingly talked-about focus point), I still couldn't find much that gave a solid edge.

That doesn't by any means we can't rally from here, it just means that I can't define the kind of edge that has occurred often in the recent past. And when I can't find what I think is an edge, I stay out. Sometimes that hurts as the market gallops higher anyway, but I'm all about trying to find a high-probability situation in order to risk my capital, and right now I ain't seein' it.

The latest Commitments of Traders data, released late this afternoon and covering positions as of this past Tuesday, didn't show much change from last week. The most notable thing about last week's report was the extreme net short position taken by "smart money" commercial hedgers in the Nasdaq 100 futures, something that has preceded declines in that index with a high degree of consistency over the past several years (I showed the chart here).

For the latest week, they reduced their shorts a bit, from $3.3 billion to $2.1 billion, but it remains an historically high amount and theoretically should be a negative factor for that index when looking out over the next several weeks to months.

Other than that, about the only thing that really stood out in the report was that small speculators (supposedly the "dumb money" in all of this), went massively short the VIX implied volatility index. But contrary to the idea that these guys are dumb money in that contract, they pretty much nailed the August high by shorting it when the VIX spiked up above 30, and their record prior to that is very mixed.

This is a relatively new contract, so I'm not going to read too much into this week's extreme. It should be bullish for the VIX (and by extension, bearish for the stock market since the two tend to move conversely to each other), but the data has been too inconsistent to suggest that's a high-probability bet this time around.

As of:

SPX 1511

HELP ARCHIVE

We've seen another volatile day today, with the S&P forming 10- to 20-point intraday cycles as it meanders between the morning high and low.

With a 50+ point drop over the past couple of days, you'd think that it would trigger a few extremes, at least among the more sensitive indicators we watch. I noted this morning that we weren't really seeing any of those, and today's additional selling hasn't triggered any more. All of our short-term indicators are still neutral, and the other types of studies I watch aren't turning up anything interesting either.

This is a bit of a change from some of the prior quick, stiff sell-offs we've seen over the past year. Typically by the time the S&P was down a couple of percent, we'd get a bunch of extremes triggering, and most often the market would accommodate by rebounding.

This lack of emotion has me sitting on my hands for trading accounts at this point, as I just can't find much of an edge either way here. I like to buy into oversold conditions during up-trends, especially with the kind of generally positive seasonality we have now, but I'm having a hard time finding any evidence that we're "oversold", or even that the recent price patterns are suggestive of a reversal. So until we get a better edge, I'm going to keep looking.

As of:

SPX 1511

HELP ARCHIVE

Good Friday morning...we begin the day with some relief, as the pre-market futures have rebounded from yesterday's shellacking and an early-morning probe lower.

After the FOMC released their rate decision on Wednesday and we saw the positive reaction from stocks and negative one from bonds, we discussed the tendency to see a reversal of those kinds of extreme moves during the next several sessions. It is very rare to get a profitable trade by chasing the reaction to those kinds of economic-inspired equity moves.

Yesterday we got the reversal, but curiously it didn't trigger very many extremes among the guides we watch. A couple of our more sensitive indicators, like the Intraday Cumulative TICK and the Price Oscillator, made it to oversold (barely), but that's not saying much when the S&P 500 got clipped by more than 40 points.

Looking back over the past 35 years, I can find only three times when the S&P 500 sold off by more than 2% the day following a rate cut by the Fed. Each time, the index suffered a bit more or chopped around for a couple of days, then took off on the upside. The average return two weeks later was +4.4%, with all three showing a return greater than +3%. Not that we can read a whole lot into three occurrences, but I've been asked a lot about possible precedents for this kind of reaction. For those curious, the dates were 11/22/82, 1/5/01 and 11/7/02.

Over the past decade, there has been a solid tendency to see a rebound from sell-offs like yesterday when the market is in an intermediate- and long-term uptrend (defined as a rising 50-day and 200-day moving average, respectively). Any time the S&P dipped by 2% or more in a single day, it rebounded the following day 70% of the time (13 out of 18) by an average of +0.4%. Within a few days, however, the probability dropped more in line with a random return during that time.

I would be remiss if I didn't note, though, that we only got these positive next-day reactions over the past decade. Prior to 1997, the S&P rebounded the next day only 29% of the time (10 out of 34) and showed a return of -0.2% on average.

I've checked a number of different reactions after moves like yesterday, regarding the magnitude of the price drop, the huge negative skew in breadth and volume, etc., both in the context of a rising market and any other time, and also during the fourth quarter or any other time.

Mostly, the results were at least moderately positive in the very short-term, more mixed in the little-bit-longer-than-short-term, then pretty much in line with random after that. The mostly positive short-term reaction is nothing surprising; we only need to look back over the past few years to see how buying into short-term panics has resulted in profit time and again.

What's bugging me about this one is that I just can't find all that many extremes, or historical stats that are ridiculously positive like we have many times in the past several years. We still have some modestly positive seasonality here, and we are still in a defined uptrend in the major equity averages, so it's hard for me to become negative after a day like yesterday, but I'm surprised (and a bit disappointed) that I couldn't find much of anything that suggests buying aggressively after yesterday is a good idea - something that would give us a better probability for success than just buying any other random day. Because of that, I'm still hanging back here and waiting for something with a better-defined edge to pop up.

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