Snapshot Notes - November 15, 2007

As of:

SPX 1490

This morning, we went over a couple of indicators that have been whipping around during the past month, reflecting the quickly-shifting nature of sentiment over such a volatile period.

One of those was the AAII sentiment survey, which has dropped to an extremely pessimistic level when using a four-week moving average. Prior instances over the past 20 years of this poll dropping to this low of a reading have resulted in intermediate-term gains nearly 90% of the time.

We also discussed our indicator which tracks the percentage of sector funds at the Rydex mutual fund family that currently have more assets now than they've averaged over the past 50 days. This measure hit 85% in mid-October, a very overbought reading that anticipated the current selling pressure, but it has already cycled down to the opposite extreme.

As of yesterday, only 9% of the funds were holding higher-than-average assets, a sign of wholesale liquidation among investors in those funds. Over the past few years, that kind of broad-based selling has resulted in intermediate-term lows with great regularity.

After prior extremes in both of those indicators, though, there was short-term selling pressure more often than not. We also have a possible expiration-related reason to be a little more guarded here, too. As I went over earlier today, when the day before option expiration puts in a performance like today, Friday has tended to be negative. Holding off until Monday and being long 'til the end of the week was quite the opposite.

Thanksgiving break is next week as well, and according to the Seasonality section of the site, the days immediately surrounding the holiday have shown a consistently positive bias.

So we now have a market that is somewhat oversold again, that has some looming positive seasonality, and that is clinging to support near the week's lows. That should set us up for higher prices into the latter part of next week, but I'm not sure how the next couple of days are going to turn out.

This afternoon's late bounce and the short-term oversold readings could be enough to suggest that we've already seen a successful re-test of Monday's lows and it's up, up and away from here. Given the questionable technical condition in the S&P and the other data we went over above, though, I'm holding off on that idea for now. I'd like to see another couple of days of choppy to weak performance to set up a better risk/reward ratio. Maybe that's trying to be too perfect in an imperfect business, but it's how I see the odds stacked up.

On a side note, tomorrow I'm heading out of town in my annual migration to the great northwoods of Wisconsin, lasting through next week. I'll be checking in with a comment after each day's close, but there will not be any intraday updates unless something extraordinary develops.

As of:

SPX 1490

HELP ARCHIVE

I need to give another nod to Jason Roney (via minyanville.com) regarding an expiration-related stat.

Option expiration is tomorrow, and according to Jason (which I've verified), if the Thursday prior to expiration does not trade in positive territory all day, and it closes below the open, then there is often downside follow-through the next day.

I can find six prior instances of this happening, and Friday closed in negative territory all six times, by an average of -4.6%. That's a breathtakingly bad return, but is influenced by September 2001. Even taking out that occurrence, the average return was still horrible at -3.2%.

Like most expirations, there was also often some weakness on the Monday following expiration. But buying Monday's close and holding until the end of the week resulted in five winners out of the six trades, for an average of +3.2%.

It would be a stretch to base any trade solely off that data, but it does line up with some other things I've been researching. The Rydex and AAII info I went over earlier showed excellent intermediate-term returns, but they also preceded short-term weakness more often than not. Buying the week after those extremes turned out better than trying to buy as soon as they hit oversold levels.

We also have Thanksgiving a week from today. As you can see from the Seasonality section of the site, the days immediately surrounding the holiday tend to be exceptionally positive (at least in terms of how often the market rises those days). Many traders know this, and will be trying to buy ahead of everyone else, so I suspect we should see buying pressure come in early next week.

A few of our short-term indicators are already hitting oversold levels, including the STEM.MR Model for the S&P 500. That's a pretty quick turnaround from yesterday's "sell" signal, but technically it will give a buy as soon as it begins to curl back up.

I was hoping we wouldn't get quite this much selling pressure so soon. It would have been ideal to see several days of choppy to negative performance heading into early next week. If we could have seen that, combined with short-term oversold conditions heading into the Thanksgiving holiday, it would have been (and perhaps might still be) a good long-side opportunity. Maybe it's "too" perfect, but I try not to outguess myself on things like that.

For now, I'm staying out and trying to be patient. We should have a pretty good long-side shot setting up in the next few days, but I'm still worried about the technical condition on the S&P and I don't wan to be too early. Monday's lows should provide support, and perhaps it'll be enough to turn the past two days around (especially since we're already seeing some oversold readings), but given what we went over above, I'm going to hold off for now.

As of:

SPX 1490

HELP ARCHIVE

Good Thursday morning...we begin the day with some selling pressure in the major indices as Banks lead us to the downside. The selling is not very broad-based at this point, and about the only real theme I'm seeing is that the sectors that ramped up the most the past few days are selling off the most now. Mean reversion at work.

Over the past month, we've seen a lot of volatility and that's brought with it a fair share of extreme readings. Earlier this month, we discussed some signs of excessive optimism, then by Monday of this week those extreme were tilted toward the opposite end of the spectrum.

In about a month's time, that number has dropped all the way down to 9% as of yesterday. The last time we saw this kind of flight from the sector funds was mid-August, which obviously was a good time to think about long-side trades.

That's been the case most of the time over the past four years when the indicator has reached this depth - there have been 31 days since October 2002 when the indicator dropped under 10%, and a month later the S&P 500 was positive 77% of the time by an average of +4.1%. The three-month return was positive 94% of the time with an average return of +10.5%. Prior to the fall of 2002, the indicator did a good job at preceding lows in March and September 2001, gave a "take it or leave it" signal in July 2001 (the market just chopped around for a month), and gave a way-too-early signal in June 2002.

We're also seeing a continued extreme in bearish opinion among the folks that participate in the AAII sentiment survey. These individual investors have switched big-time from their too-bullish thoughts from late September, and have been mired among the pessimists for the past couple of weeks, dragging the four-week average of the bull ratio below 45% for the first time since last summer.

Over the 20-year history of the survey, when the four-week average drops to this low of a level, the one-month forward return in the S&P has averaged +1.8% with 72% of the weeks being positive. The three-month return averaged +5.4% with an impressive 89% of them positive. The ratio dropped this low three distinct times during prior Novembers (1989, 1990 and 1992), and equities rose into the end of the year all three times.

When we take the data above and combine it with some of the other developments from late last week and Monday, the case seems to be getting quite strong that we should see a year-end rally.

The short-term is more questionable. When we got the big gap up yesterday morning, the risk/reward seemed to tilt back to neutral, and as the morning wore on we got "sell" signals from the STEM.MR Model in both the S&P 500 and Nasdaq 100.

Stocks rolled over soon thereafter, which is disappointing...during strong thrusts out of intermediate-term lows, the indices will often continue higher despite these kinds of overbought readings as buyers continue to rush into the market. We're not seeing that kind of buying interest now, making the short-term up for grabs.

I mentioned yesterday afternoon that I was intending to stay away from risking capital in trading accounts until I saw a better-defined edge, which I thought may come if the S&P was able to break out and hold over 1490ish, or we saw a return to test Monday's lows. A re-test of recent lows is a very scripted setup that "everyone" looks for (the assumption being, then, that since everyone is looking for it, it won't happen), but I still find that kind of general pattern to be successful. From the looks of yesterday afternoon and this morning, we may get that re-test instead of a breakout, but we'll see how things look as either situation approaches.

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