Snapshot Notes - December 13, 2007

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THURSDAY, DECEMBER 13, 2007

Market Should Recover if Banks Find Value Buyers

12/13/07 4:20 PM EST

As of:

SPX 1481

Coming into today, we were coming off an extreme oversold reading in our shortest-term models, the types of readings that have consistently led to higher prices over the next couple of sessions.

The odd thing about those readings is that they hit such extreme readings on a day when the broader indices were actually in positive territory most of the day due to the gap up open yesterday. That odd kind of setup is something I kept running into in trying different historical tests - it was difficult finding any comparisons to our current situation.

One thing that seemed clear was that if yesterday's low was violated, then it would usher in a handful of bearish short-term precedents. After an intraday reversal from a gap open like yesterday, a violation of that day's low led to some swift and severe selling pressure in five of the six previous instances we've witnessed.

At least for today, the indices were able to hold on, as the S&P 500 flirted with those lows most of the day before recovering into the afternoon. After Tuesday's big down day, the index has now carved out a couple of long "tails" , which form when the index opens and closes far above its lows for the day. Generally, those are moderately bullish patterns in the very short-term (the S&P was positive about 61% of the time the next day; returns further out were still positive but more in line with random).

Adding some potential for a short-term rebound is the severe selling pressure in the financial sector. Earlier this afternoon I went over a stat related to the current pattern in the BKX Banking Index, as it closed in negative territory for three straight days and clipped more than 8% off its value.

Returns going forward after prior instances have been very positive, particularly when looking out one month, but even the short-term looked quite good. That index is in a bear market as far as I'm concerned, but that does not at all preclude short- to intermediate-term rallies from severely stretched conditions, which is what we're currently seeing.

If the banks do manage to attract some value buying here, then that should also coax the broader market higher. So we have a collection of at least mildly bullish factors coming together at this point, which seems to tilt the risk/reward to the long side. We're seeing some very volatile moves and unusual developments, so I'm a little more skittish than I otherwise would be this time of year, but it still looks decent provided we're able to stay above the recent lows.

Have a great night and we'll see you tomorrow!

If Banks Bounce, so Will "The Market"

12/13/07 2:20 PM EST

As of:

SPX 1481

HELP ARCHIVE

We've had a few occasions to go over some price-based extremes in the BKX Banking Index over the past couple of months, and get another chance today.

That index has had three consecutive down days, with a total loss during those sessions of more than 8% (assuming we close at or below current prices). That's some serious selling pressure, and has typically been bullish in the past. The one-month return going forward averaged +7.7%, with 11 out of 13 distinct instances throwing off a positive return using data since 1993.

The maximum loss during the next month averaged -6.1%, so it certainly wasn't without risk, but the maximum gain averaged +11.8%. That's not quite the 2:1 reward/risk ratio I prefer to see to consider something a solid edge, but it's close enough, particularly given the sample size.

The more unusual thing about this instance is that we're not (yet) setting new lows. I re-ran the test, but this time stipulated that the BKX index could not be making even a new one-month low. In that case, only three precedents popped up, those being 10/01/98, 01/14/99 and 08/05/02. In all three cases, the selling pressure was a re-test of a prior oversold low.

Also in all three cases, the index bounced hard the following day, averaging a gain of a whopping +3.8%. But in the two earliest instances, the index rolled over immediately after that up day and headed to new lows before putting in a more lasting bottom during the next one to three weeks. In the 2002 case, the index was able to rally for a few weeks before ultimately rolling over. I'd want to see the index hold above the lows set in November today, and if it does I'll be looking for that index to try to bounce over the short-term.

Any bounce in the financials should lead a bounce in the broader indices, and I like the fact that the S&P 500 is holding above yesterday's lows so far today. As I mentioned this morning, a violation of that area (around 1470) would usher in a handful of ugly precedents for the short-term.

As a further potential positive, we're technically getting a buy signal from the STEM.MR Models, as they've reached deep oversold territory and have started to curl higher. If the bulls are going to take a shot, it seems like their opportunity is here - as long as yesterday's lows hold up.

Treading Cautiously

12/13/07 9:25 AM EST

As of:

SPX 1481

HELP ARCHIVE

Good Thursday morning...We begin the day with solidly negative overseas markets, some "positive" economic news, spiking bond yields and a fairly large gap down open in the major indices.

Yesterday, I went over how unusual some of the recent volatility has been, as it's been difficult to find many (or any) precedents for this type of price action. While we rarely find anything that's an exact fit, there is usually a way to find several comparable time periods that help us flesh out a piece of what we might expect going forward, and add context to what the sentiment and technical guides are suggesting.

Those guides are mixed at the moment. The shortest-term indicators that we follow are neutral to oversold, with the most notable among them the STEM.MR Models for both the S&P 500 and Nasdaq 100. Because they use half-hourly data, they didn't have time to reflect yesterday's gap up opening, and drifted lower throughout the day. Both are now well into "excessive pessimism" territory and at their most-stretched position since mid-November.

Typically, when we enter a day with those models in oversold condition and a gap down open, I'd look to be a buyer. One big caveat here is that when we see gap down opens after a big intraday reversal the prior day, it has often led to more selling pressure if the low of the reversal day gets violated.

What that suggests now is that if yesterday's low of 1470 in the cash S&P 500 index fails to hold, then there is a higher likelihood of seeing even more selling pressure in the short-term (the S&P dropped an average of another 2% over the next two sessions, with five of six instances showing a negative return). Another 1% - 2% drop would fit in with the Fed reversal stats we went over on Tuesday, and take us down to previously mentioned potential areas of support.

An aggressive entry would be trying a long position at today's gap down open, but I'd be very cautious with that trade and be pretty quick to eject it if we fail to hold yesterday's low, which is not far from where we're indicated to open. It doesn't seem like a bad risk/reward spot since the stop is so close, but it could turn out to be a very, very short-term trade given the volatility we've experienced. Personally, I'm still holding off for now - I want to see if yesterday's low can hold.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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