Snapshot Notes - November 13, 2007

As of:

SPX 1457

Heading into today's session, we were piling up a rapidly increasing number of indicators and studies suggesting that the recent price drops were excessive.

We went over a couple of those again this morning, dealing with the Stock/Bond Ratio that we post to the site, and the recent string of 2% down days in the Nasdaq 100. Combined with the large green list in the "Indicators at Extremes" section on the Daily Overview page, and the tendency to see mid-week rebounds after a big down Monday, it seemed like the bulls had better put up or shut up, and right quick.

Put up they did, as we enjoyed a rare trend day to the upside. We've had numerous bullish setups over the past month, many of which did generate some upside, but almost all of them petered out within a couple of hours. Not only did this one stick around all day, but it even came on the heels of an exceptionally large gap open, which makes it all the more impressive (since large gap opens tend to fade during the day).

With the kind of rebound we saw today in the major indices and even some of the more specific ones involving financials, the odds seem to favor a continued respite from the selling, at least in the short-term. When these indices jump like this from oversold conditions, buyers tend to keep pushing things for a few days. While there is often some fallback in the very short-term, by a week later the indices have tended to show positive returns with good consistency, as we went over earlier this afternoon.

For the past few days, I'd been looking for some signs of price stabilization to lend some confidence to the bullish developments we'd gone over, and today would certainly qualify. I wouldn't be at all surprised if we gave back part of today's gains over the next day or two, but I fully expect any possible losses in the very short-term to be erased and see higher prices than today's close.

As of:

SPX 1457

HELP ARCHIVE

This morning I mentioned that although we had quite a confluence of extreme oversold readings heading into this morning, a large gap up opening is not exactly what I wanted to see. Time and again, we've seen these large gaps fade, and that's not the kind of thing we needed right now.

I briefly went over some stats which showed that in the past when we've seen this kind of gap open, the S&P 500 tends to close lower than the open about 70% of the time. That's why I wanted to see the opening prices hold past the first hour to get more comfortable with the idea that the buyers might finally be willing to stick around this time.

Stick they have, and it has turned into a nice trend day. I went back to those same occurrences I wrote about this morning and looked for any instance when the futures closed more than 1% higher than the open (after gapping up more than .75%). There were only two precedents, so unfortunately we're limited in extrapolating anything meaningful to our current situation, but for those curious the dates were 10/21/87 and 1/11/88. Both resulted in extreme short-term volatility, and eventually to higher prices, but again I don't think we can read much of anything into that.

I pulled back and looked at the cash S&P 500 index back to 1950, to see if there were any instances of the index being down as much as it was over the past week, then enjoying a +2% rebound. I found 12 instances, and the general pattern afterwards was some weakness in the very short-term (the S&P closed lower the next day 7 of the 12 times), then another push higher (it was positive a week later 9 of the 12 times).

The broader market may continue to get help from the financials, which are providing the spark today. In the history of the XBD Broker/Dealer Index, there have been 23 times when it was within a whisper (0.5%) of a two-month low, then exploded higher by 4% or more. A week later, it added further to its gains 17 times with an average of +4.6%. That bled over into the S&P 500 as well, as that index was higher 66% of the time with a return of +1.7%.

Assuming this trend day continues into the close, (and it should - trend days that last this long into the afternoon tend to close at or near the day's high), the probabilities look good for a continued rebound in the short-term.

As of:

SPX 1457

HELP ARCHIVE

Good Tuesday morning...we begin the day with a large gap up open across all the major indices. Coming on the heels of the past week, though, I'm not convinced this is necessarily a good sign...more on that below.

One of the indicators we update daily on the site is the Stock/Bond Ratio, which looks at historical movements between the two asset classes and tries to measure when they get out of whack. The assumption is that when that's the case, then the relationship moves back towards a recent historical norm.

I've written about the ratio about a dozen times over the years, as it only rarely moves to an extreme. One of those times happened yesterday.

While I like to see moves under -3 to get really intrigued, that's exceedingly rare. Yesterday's reading of -2.2 is enough to get me interested, though - essentially, it means that the two assets have moved so far out of alignment that it is 2 standard deviations from normal.

Over the past few years, a reading this extreme has been nearly perfect at pinpointing equity lows. There have been 13 days since October 2002 that showed an indicator reading less than -2.2, and a month later the S&P 500 was higher all 13 times by an average of +4.5%. Incredibly, the average drawdown during the month (the most that the trade moved against us since the entry date) was an unbelievably small -0.6%, compared to an average maximum gain of +5.3%.

The past few years have been exceptional, though, so if we zoom out and look at any time in the past 40 years it has become this extreme, then still the S&P was higher a month later 63% of the time with a +1.1% average. If we stipulate that the S&P be in an uptrend at the time of the extreme in the Stock/Bond Ratio, then the one-month forward return doubles to +2.0% and the winning percentage shoots to 80%.

If we look at it one more time, this time adding the filter of it being November, then historically there were 10 prior instances, and all 10 showed a positive one-month return, averaging +5.3%. Those instances covered four unique periods beginning 11/1/71, 11/8/76, 11/14/78 and 11/22/91.

The reason for the extreme reading in the ratio is due to just how swift and severe the last week has been. As of yesterday, the Nasdaq 100 was down 2% or more for four consecutive days, the first time we've seen such unabashed selling since July 23, 2002. Looking back over the history of that index, I can find four cases: 10/20/87, 4/13/00, 12/15/00 and 7/23/02. The next day the index bounced back twice, and within three days was higher three of the four times.

Some of that pressure is being relieved in the pre-market, with the major indices up between .75% - 1.5%. Although I'm looking (and positioned) for at least a short-term rebound, a large gap up open is not necessarily what I want to see. We've gone over this kind of thing many times before, but as an example, any time the S&P futures were down as much as they were over the last week, then gapped up .75% or more, the index closed lower than its open 71% of the time, and had an average return of a woeful -1.0%.

Because of that, I'm wary about reading too much into this gap open. We have a big cluster of oversold readings among our indicators, so the time is ripe for an oversold rally, but the reversal of a big gap up open would not be a good way to start. If we can hold the opening prices for the first hour, then I'll become a bit more comfortable with the buyers' desire to commit.

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.