Snapshot Notes - November 28, 2007

As of:

SPX 1490

The week leading up to Tuesday had generated a number of historical extremes among the guides that we follow. From sentiment surveys to stock/bond relationships to breadth to volatility, we had accumulated a long string of measures that have reliably preceded intermediate-term rallies.

The one thing we hadn't seen was follow-through, and an interest from buyers to find value in the depressed prices and even more depressed sentiment. We finally got a hint of that yesterday, and then for the first time in nearly a month, a second consecutive up day today. And what an up day it was, with the S&P carving out its 3rd-largest percentage gain in four years.

This morning, I went over some data that suggested that such a follow-through day should have positive repercussions for the intermediate-term. Previous instances of seeing back-to-back 1% gains in the S&P 500, after it hit at least a six-month low in the days prior, consistently led to further gains. It has happened twice in the past decade (March 2001 and October 2002), which both adhered to that pattern.

When we see such a large and steadily positive day like today, it would be unusual if our shorter-term guides didn't become overbought, and we don't have to worry about that today. All of them moved into "excessive optimism" territory by the afternoon, including the STEM.MR Models. The last couple of times the models moved above their upper trading bands, the equity indices promptly fell apart, so this is a good test.

Many times in the past when we're trying to emerge from oversold conditions, our shortest-term stuff will hit overbought extremes, but then prices will either just gently consolidate for a few days, or sometimes manage to continue rising. That is a good sign of strong buying interest, and it's something I will be keenly looking for this time around as well.

We have most of the pieces in place for a sustained rally going into the new year, and price confirmation like that would be the last piece of the puzzle. For the short-term (looking at the next one to three days), I'm not counting on much more upside, at least not that I think will be sustained, but as long as we don't give back too much of these gains, the prospects for more upside in the coming weeks just got a whole lot brighter.

As of:

SPX 1490

HELP ARCHIVE

Today has held well to the template of a trend day, where a market opens at its low and closes at or near its high.

Buying pressure has come in every time the NYSE TICK has dared venture close to or below the zero line, taking us to new intraday highs each time, and overbought extremes in the TICK have resulted in only very minor pullbacks. Typically, when a day displays these characteristics so far into the afternoon, the indices close at or near its highs for the day.

We're currently on pace for the 3rd-largest one-day gain in the S&P 500 since the bull market kicked off in March 2003, the other two occurring just in the past couple of months (09/18/07 and 11/13/07).

As so often happens after such extreme moves, the S&P pulled back after both of those occurrences. Just looking for any +2.5% daily gain in the S&P over the past decade, it was positive three trading days later about 45% of the time, and showed an average return about equal to 0%.

In the process of carving out such a positive day, it's no surprise that our short-term guides have become grossly stretched. All of them are currently in overbought territory, and the STEM.MR Models have also pushed into "excessive optimism" territory.

That has been an almost immediate death knell for prior rally attempts during the past couple of months, and will be another good test of the potential that we're in the midst of hammering out the intermediate-term low that so many of our longer-term indicators are suggesting.

A strong market emerging out of severe oversold conditions tends to either roll right over these types of overbought readings, or gently consolidate over the next several sessions, so the behavior over the next few days should give us a pretty good clue about how likely a December rally is.

Some backing off from these overbought readings is to be expected, but we shouldn't retrace much more than 50% or so of today's gain during the next several sessions, or I'd have to more seriously question the idea that we've seen the low.

Bottom line, I think there's a decent shot that we'll close near the day's high (though I can't imagine there's much upside left), then see much choppier conditions over the next few days, with further upside attempts being fairly limited and not lasting, before a more sustained push higher into December. The more upside we get over the next couple of days, the likelier it is that Monday marked a major low.

As of:

SPX 1490

HELP ARCHIVE

Good Wednesday morning...We begin the day with another large gap up open in the major index futures. Large gap opens beg to be faded (i.e. traded against), as we've gone over time and again, so we'll see if buyers have enough interest to defend today's gap. If so, it could prove to be important confirmation as we'll go over a bit later.

One of the things nagging me about this particular batch of oversold readings is just how recognized they are. I didn't get the same impression in March or August when we were seeing similar readings, but when far less commentators were suggesting that a good buying opportunity was at hand. Perhaps it's just seasonality, with so many people aware of how December has traditionally been the most consistently positive month of the year.

This quick switch in sentiment can be observed by looking at the Equity-only Put/Call Ratio from the Chicago Board Options Exchange (CBOE). That contrary indicator has recorded a couple of readings suggesting excessive pessimism over the past week or so, but it has been very quick to move into excessive optimism territory during the one-day upside wonders we've seen, including yesterday.

This is different from past intermediate-term lows of the prior few years. Let's look at how many trading days it took during the past few years from the time the S&P 500 carved out its low until the Equity-only P/C Ratio jumped into "excessive optimism" territory by moving above its upper trading band:

On average, it took 19 trading days to reach the kind of level we're seeing after only one day of rallying.

The interesting thing about this juncture is that both bulls and bears appear to have conviction about their outlooks. The latest lowrisk.com sentiment survey showed that only 5% of respondents were neutral, while the rest were split nearly evenly between bulls and bears. There have been only two weeks in the ten-year history of the survey that showed as low or lower neutrality, those being 05/12/00 and 11/24/00. After both, the DJIA made a 300+ point move over the next one to two weeks as one side saw the folly of their ways and quickly switched camps.

We can also see conviction among Rydex traders by looking at the Enthusiasm Index. Ignore whether the bars on the chart are bullish or bearish for a moment, but instead focus on the length of them. For the past six months, the Index rarely moved outside of +.15 to -.15. Over the past several sessions, however, the magnitude of the moves has averaged twice that - meaning that these folks are switching money between the bullish and bearish funds at a furious pace, taking strong stands one way or the other. When they have changed their mind, they have put serious money behind it.

It's typically a good sign of renewed buying interest when markets gap higher at the open, and close higher than the gap, when emerging from oversold conditions. We got that yesterday, and it would be nice to see it again today.

I looked back over the past 57 years in the S&P 500, and searched for any time the index made a six-month low, then carved out two consecutive +1% closes. A week later, the index was higher 79% of the time (15 out of 19 instances) by an average of +2.0%. A month later it was positive 68% of the time with a +2.5% average return, and three months later it was positive 84% of the time and sported a +7.0% return on average.

This has happened twice in the past decade, those being 03/26/01 and 10/11/02. Both were good trading lows, so this may be another good sign if we're able to hold today's gap open and close well on the day.

We have the setup for a run into the beginning of the new year, we have a very polarized trading population that can fuel the fire if the bears begin to cover, and we're now getting some actual price evidence of this taking hold. In spite of a few minor nagging points, it should be welcome confirmation if we close well today. I don't think it would be necessary to rush in and buy - there is very often some testing of a potential low - but this is the type of thing I want to see to become more aggressively positioned with longs.

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