Snapshot Notes - November 9, 2007

As of:

SPX 1457

Coming into today, we were facing another extremely large gap down opening in the index futures, the fourth gap down of more than 0.5% this month.

This kind of a see-saw of large gap openings is rare. We've really only seen it three other times in the past decade, those being October 1997, October 1998 and September/October 2002. All of those instances showed very positive returns in the intermediate-term when looking ahead, but there was also a lot of shorter-term volatility in the meantime.

Today certainly qualifies as volatile. Heading into the final hour, the indices looked good - the intraday reversal in the S&P, while coming out of oversold breadth conditions, had a handful of positive precedents over the past 20 years, and it looked like the reversal had a good chance of sticking. The straight-down last hour thoroughly negated it, though, and the only place where that reversal stuck was where the sun doesn't shine.

It's been extremely tough to get any upside follow-through on these seemingly positive developments. A couple of times over the past two weeks, we got what appeared to be good long-side signals, and the indices did jump higher off of them, but then rolled over soon thereafter. Yesterday's "buy" signal from our models saw a nice-sized rally that lasted only an hour before being reversed.

That's not the kind of behavior we often see in healthy markets. Today's afternoon rally had the potential to build some kind of base for a further short-term push higher, but the breathtaking last-hour swan-dive calls even that into question.

Going into next week, we're in a precarious position, especially after that last-hour debacle today. The S&P 500 is in a weak technical condition, and we have only a smattering of oversold signals.

We discussed a few things this week that suggested additional short-term pain ahead, then a nice rally into the beginning of next year was the most probable scenario. Given the weakness yesterday and today, then this afternoon's reversal, I thought we'd at least see a short-term bounce, and then we could go from there as to whether it might lead to something longer-term. The last hour threw a wrench into things and frankly at this point I'm not quite sure what to expect heading into Monday.

The latest Commitments of Traders report was free of anything remarkable in terms of the equity indices, as commercial hedgers added a bit to their net long position while small speculators pulled back in turn. Neither one is currently near an extreme in sentiment.

The large net short position by "smart money" commercial hedgers in the Nasdaq 100 contracts that I wrote about in late October (which worked out quite well indeed for those traders) has been covered to some extent. Instead of being short by a nominal $4 billion as they were then, these large traders are now short by $1.5 billion. That's still moderately high, but no longer what I would consider extreme. Bulls hoping for better news will have to wait - I wouldn't consider it bullish for the NDX unless they shifted all the way to the other extreme, and became net long by $3 billion or more.

As of:

SPX 1457

HELP ARCHIVE

The indices are in the midst of trying to put together a couple of impressive afternoon rebounds in a row, after they (barely) undercut the first-hour lows in the mid-morning.

These types of reversals from oversold conditions tend to stick, at least for a few days. I looked for any time the S&P 500 futures gapped down at least 0.5% on the open, then closed at least 0.5% above the open...after the 5-day Up Issues Ratio had closed at 35% or less the day before.

I was able to find five occurrences, and three trading days later the S&P was positive all five times by an average of +2.6%. The average drawdown (i.e. maximum loss) during the three days was less than 1/3 the average maximum gain (-1.0% compared to +3.4%).

I'm assuming the afternoon rally is going to hold, but combined with yesterday afternoon's buy signal from the STEM.MR Models, the time seems to be ripe for buyers to step in and try to push us higher in the short-term. My guess is the S&P is going to have some stiff resistance around 1500, but we should be able to make it at least to there by mid-week next week.

As of:

SPX 1457

HELP ARCHIVE

Good Friday morning...we begin the final day of the week with yet another large gap open, this time to the downside. Once again we can take our pick as to which piece of bad news is responsible - there's a lot to choose from this morning.

We've seen this kind of large opening-gap cluster only a few times over the past decade - October 1997, October 1998 and September/October 2002. The intermediate-term returns after each instance were extraordinarily positive, but there was a lot of shorter-term volatility on the way there.

Adding to that thought, Wednesday afternoon and again yesterday morning, we went over some developments related to the banking sector and the patterns in the general equity market that suggested some additional short-term pain was ahead, but then we should see a very trade-able low sometime this month, lasting through the first part of next year.

By yesterday afternoon, our more sensitive indicators had reached "extreme pessimism" status, with the STEM.MR Model for both the S&P 500 and Nasdaq 100 curling up and giving "buy" signals. It didn't take the indices long to respond, and they bounced hard into the close.

That kind of reaction is good to see, but obviously we're not getting a lot of traction this morning. During healthy uptrends, buy signals from those models tend to precede two or three days (at least) of generally rising prices - not just one hour.

I mentioned yesterday afternoon that although the risk/reward finally seemed to be tilting to the long side, with the S&P in a precarious technical position I had no intention of trying to be aggressive with long trades, and this morning's reaction is just more confirmation that long attempts should be kept light and short-term until we see some stabilization.

From the stuff we've gone over this week, it seems as though we're within a week or two of a good low, but it could be dicey in the meantime, so I'm going to continue to take it conservatively until it seems we don't have this constant feeling of a shifting floor under our feet.

I mentioned a stat from Jason Roney (via minyanville.com) on Wednesday that proved helpful. Basically, it suggested that on any gap down of 1% or more in the S&P 500 futures, if the contract goes on to make a lower intraday low after the first hour of trading, then the probability of a meaningful later-day rebound declined significantly. If the opening low holds, however, then the chances for an intraday rebound later increase, so I'll be watching that again today.

In the history of the S&P 500 tracking fund, SPY, buying into very large gap down opens on a Friday and holding until Monday's open was successful about 70% of the time, so that's also something to consider if we hold this morning's opening low. If that holds going into the close, then I'll look at bumping up some long exposure into the weekend. Be aware that futures trading on most bond contracts closes early today, and are closed all day on Monday, so given the credit concerns we're dealing with now, equity trading may slow considerably.

Forwarding or otherwise distributing this copyrighted material is a breach of your subscriber agreement. Violators are subject to termination of their subscription with any received subscription fees forfeited. Any references to historical performance are based on data we deem to be reliable, but are based upon feeds from third parties. We do not recommend subscribers take positions based on data presented here alone, but rather incorporate it into a comprehensive investment outlook.