Snapshot Notes - December 12, 2007

As of:

SPX 1513

It seems like I've been starting a lot of sentences with "it's been a long time since..." lately, given the number of unusual developments we've seen.

So, heck, what's one more: It's been a long time since we've seen this big of an intraday reversal, coming after such a monstrous gap up open. Since 1994, I can find four other times when the S&P 500 gapped up 2% or more, then closed at least 1% below the opening print.

Those four were 10/06/98, 12/08/00, 07/17/02 and 04/07/03. In three of the four cases, the S&P just continued to slip lower over the next couple of sessions, losing at least 2% before rebounding (in the 2002 instance, it lost more than 10% over the next week as we headed into the waterfall decline that ended up marking the low). In the December 2000 instance, we saw a huge jump higher over the next couple of days, then an even "huger" drop that more than erased those gains.

I've been scrambling all day trying to find some kind of comparables to the recent activity, but I gotta tell ya, it's been tough. We're in a very unusual situation here, what with the magnitude of the post-Fed sell-off, then the big gap up today and the steady failure since then. Every day is a unique moment in market history, of course, but very often we can at least find a rhyme for our current circumstances if we look back far enough. I've gone back as far as I can go today, and haven't turned up much of anything that helps with this mess.

There is a kinda-sorta compelling case for the long side, at least according to our most sensitive indicators. Since all of today's gain came in the form of a gap up opening, the STEM.MR Models didn't have time to process any of the enthusiasm that may have been expended. So it is mostly reflecting just the selling pressure from the first trade today, and combined with yesterday's horrific dip, it's dropped well into "excessive pessimism" territory. That's very odd to see when the S&P is still very much in positive territory on the day (in fact, I don't think I've ever seen such a thing), but these are odd times.

There are also the "Fed reversal" stats we went over yesterday, which tell us that extreme reactions to economic events like a Fed announcement are consistently good contrary indicators when looking out over the next week or so (especially if we got an additional 1% - 2% of downside during the next couple of sessions), and as we noted then, the market has a pretty good tendency to rebound after stiff post-Fed sell-offs.

We also have the multitude of intermediate-term extremes that we detailed ad nauseam during mid-November which suggested higher prices over the next one to three months. It's possible that we've already expended much of the goodwill created by those extremes, but given the sheer number of extremes we saw then, and of course the current positive seasonality, I'm inclined to still consider them a positive influence here, although significantly diminished from the kind of sway they likely held over the past few weeks.

I would have preferred to see the S&P hold above 1490ish, which has been a popular area for it to stop and reverse over the past couple of months. I count six distinct times when that general area either stopped a decline or halted an advance since October, and that's the kind of thing most shorter-term traders don't easily forget, so it's failure to hold over the past half-hour is disappointing.

Given these factors, my approach is still to look for long-side entries. I'd like to see the S&P reverse back above 1490 to have a bit more confidence that we are, indeed, oversold enough to matter. Barring that, I'll be on the lookout for that gap down open or significant early-morning selling pressure tomorrow that I was looking for today, before taking a stab at a long-side trade. I don't have a specific downside area I'm watching, though 1460 seems like a magnet for traders, as it was last week's low, and a 50% retrace of the rally off the November lows.

As of:

SPX 1513

HELP ARCHIVE

Good Wednesday morning...We begin the day with the pre-market futures on fire after the typical post-Fed reaction wore off and just-released news of a coordinated Central Bank liquidity injection.

There have been only two times when the S&P 500 dropped at least 1% the day of an FOMC meeting, then gapped up at least 0.5% the following morning (08/22/01 and 09/25/02). Both sessions closed higher than the open by an average of +0.7%, but both also rolled over and hit lower lows within a week.

Ignoring the fact that yesterday was a "Fed" day, there have been 33 times since 1994 when the S&P 500 proxy, SPY, dropped more than 2% one day then gapped up 0.5% or more the following morning. The S&P managed to claw to the upside the majority of the time, closing higher than the open 70% of the time by an average of +0.3%. Buying that day's close led to moderately negative returns in the very short-term and random returns after that.

As I went over yesterday, extreme reactions to economic releases tend to provide consistent opportunities to "fade", meaning trade in the opposite direction of, the initial reaction. We've seen that time and again this year, and apparently we're going to get it yet again this morning.

As I was typing this, an announcement hit the wires that the Fed and ECB will coordinate to provide liquidity to the markets. That spiked the futures even further, with the S&P now up more than 2% in the pre-market, marking the 2nd-largest gap since the bull market began more than four years ago (the largest was August 17th, also a time when the Fed made a surprise announcement).

Historically, these exceptionally large gaps of 2% or more led to mixed performance going forward, but it's difficult to read much into them since the majority occurred during the depths of the bear market when volatility was much higher. A better measure would be to look at the gaps in terms average true range instead of a straight percentage, but even when we do that we come up with pretty much the same examples. I couldn't find any particular edge when looking at past gaps as large as this one.

I noted yesterday that I thought the sell-off we saw into the afternoon was more of a positive than a negative going forward, but I was holding off buying for trading accounts unless we saw a gap down open or some early-morning selling pressure. We're getting the exact opposite this morning, though, and I don't like the odds of buying into a large gap up open. I can't find much that necessarily suggests that trying to short the open is a good idea, but I'm going to have to stay back here and see how the gap gets treated before trying to take any positions. This is an exceptionally volatile tape at the moment and taking a position at the wrong time and without a strong edge can lead to immediate and stinging losses.

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