Snapshot Notes - November 5, 2007

As of:

SPX 1511

Over the past couple of days, I've been lamenting the fact that despite some pretty heavy selling pressure, I couldn't find much evidence that we're oversold.

"Oversold" can have 10 different meanings if you ask 10 different people, but for me I define it as simply any time the indicators or studies we watch line up to suggest that prices have a better probability to rise (and rise farther) than falling.

Typically when we see the kind of pressure we've had the past three days, we'd be seeing a bunch of indicators and/or price- and breadth-related studies suggesting a short-term low is at hand, particularly when we're in the midst of an uptrend, and especially during the fourth quarter. I'm not sure why, but I haven't been able to find many of those lately.

One thing that's catching my attention today is the large gap down and inability (so far) of the S&P 500 to close its morning gap (i.e. today's high is lower than Friday's close).

The last time we saw a 1%+ gap down on a Monday morning, and a failure of the S&P to close the gap, was May 17, 2004. That actually marked the low as the S&P went on to march higher for the next month. The time before that was March 31, 2003 - also a notable buying opportunity.

The other precedents weren't quite so all-out bullish, but they were pretty positive. Almost always, we bounced back the next morning, as the S&P 500 tracking fund, SPY, gapped up Tuesday morning 11 out of 13 times, and closed higher 8 times with an average return of +1.2%. The next few days all gave about the same odds of being positive, and by a similar magnitude, suggesting that the bulk of the bounce was made up very quickly.

With more bad news coming from the financial sector this weekend, it's hard not to be reminded of 2002 when all the junk from Enron et al was being aired. Massive write-offs, fired CEOs, shareholder lawsuits...it all seems familiar.

While the declines in most brokerage stocks have been far, far less than what we saw with the others during 2001 and 2002, the past few days have been especially brutal. The XBD Broker/Dealer Index has now been down for three straight days, with a total loss during those few days of more than 10%.

That's the first time since October 7, 2002 the sector has undergone this kind of concentrated selling pressure - not coincidentally a time when investors were trying to wrap their heads around the frauds being perpetrated at that time. That day actually marked the bear-market low for the sector.

Going back a bit further, the other "3-day, 10% loss" instances in the XBD also frequently marked something of at least a short-term low. Since 2000, any time we got that kind of selling pressure over a 3-day window in the XBD, the index was higher three trading days later 12 times out of 13 occurrences by an average of +4.4%. Prior to 2000, the short-term returns were similarly consistent and impressive, with the exception of August 1998 when it continued to slide farther south.

A rally in the S&P should be a fore-gone conclusion if the brokers can find some kind of oversold bottom here. Our more-sensitive indicators are still mostly neutral at this point, which is curious since they've cycled into oversold in the recent past with much less selling pressure. Still, if the S&P 500 cash index can hold that 1490ish area, then we should be able to see some short-term relief over the next one-three days based on the developments we went over in the paragraphs above.

As of:

SPX 1511

HELP ARCHIVE

Good Monday morning...we begin the new week with the major indices trying to recover from a large gap down open. Every sector I follow is in the red this morning, led once again to the downside by Brokers, Banks and Retail. The indices I watch for the latter two are currently trading below their August panic lows.

We left off last week with a fairly unusual situation - despite heavy selling pressure going into Friday morning, I couldn't find much of anything that suggested that Thursday's wallop was a good buying opportunity.

I consider that unusual since we've seen similarly bad days several times over the past few years, and almost always we found a bevy of extremes that suggested buying into that kind of pressure was the right thing to do. And for the most part, that proved to be the case.

But after Thursday, I couldn't find that kind of evidence. I looked at Thursday's trading from a multitude of different viewpoints, but none of them provided a solid edge. Other than perhaps a next-day rebound kind of thing, most of what I found suggested forward returns no better or worse than random.

When I see that kind of situation, I stay away. I don't like risking my capital when I can't define an edge, and that was certainly the case late last week. For the most part, I'm happy with that decision, as we've seen some wicked chop the past couple of days, culminating with a large gap down this morning.

Typically, large negative gaps on a Monday are a sign of built-up capitulatory selling from the weekend - buying any 1% gap downs on Mondays in the S&P 500 fund, SPY, and holding until the next day's open resulted in 15 winning trades out of 20 attempts - but after those knee-jerk rebounds, S&P returns were mixed in the days following.

This weekend, I went over a couple of troubling signs that had popped up, though overall our guides aren't tilted too heavily to the "excessive optimism" camp on an intermediate-term basis. I'm still looking for a choppy environment to continue, where buying oversold and selling overbought should work better than trying to buy and hold either long or short.

At the moment, I'm not seeing much that suggests we're oversold. The S&P 500 is getting there, and I like the fact that it's been able to hold above 1490, which has become quite the line in the sand for a lot of short-term traders. At this point, though, I still can't find much that suggests trying the long side is yet worth the risk. Maybe for very short-term traders, the Monday-morning knee-jerk reaction might give an opportunity to fade the mini-panic selling pressure, but I can't find anything that suggests it's good for a multi-day trade.

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